**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549**

**FORM 10-Q**

**(MarkOne)**

**x****Quarterly Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

**for the quarterly period endedSeptember 30, 2006.**

**Or**

**o****Transition Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

**for the transition periodfrom                              to                             **

**Commission File Number 000-50266**

**TRINITYCAPITAL CORPORATION**(Exact name of registrant as specified in its charter)

| **New Mexico**            |   | **85-0242376**                           |
|---------------------------|--------|------------------------------------------|
| (State of  incorporation) |   | (I.R.S. Employer  Identification Number) |

 

**1200 Trinity Drive, Los Alamos, NewMexico 87544**

(Address of principalexecutive offices)

**(505) 662-5171**

Telephone number

Indicate by check mark whetherthe registrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90days.  Yes x No o

Indicate by check mark whether the registrant is alarge accelerated filed, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer” and “large accelerated filer” in Rule 12b-2of the Exchange Act. (Check one)
| Large Accelerated Filer  o | Accelerated  Filer  x | Non-Accelerated  Filer  o |
|--------------------------------------|---------------------------------|-------------------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Act).   Yes  x  No  o

APPLICABLE ONLY TO CORPORATEISSUERS:

Indicate the number ofshares outstanding of each of the issuer’s classes of common stock, as of thelatest practicable date: 6,533,691 shares of common stock, no par value,outstanding as of November 3, 2006.

 

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**TRINITYCAPITAL CORPORATION AND SUBSIDIARIES**
|       | **PART I.  FINANCIAL INFORMATION**                                                     | ** ** |
|------------|---------------------------------------------------------------------------------------------|------------|
|       | ** **                                                                                  | ** ** |
| Item 1.    | Financial Statements                                                                        |       |
| Item 2.    | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |       |
| Item 3.    | Quantitative  and Qualitative Disclosures About Market Risk                                 |       |
| Item 4.    | Controls and  Procedures                                                                    |       |
|       |                                                                                        |       |
| ** ** | **PART II.  OTHER INFORMATION**                                                        |       |
| ** ** | ** **                                                                                  |       |
| Item 1.    | Legal Proceedings                                                                           |       |
| Item 1A.   | Risk Factors                                                                                |       |
| Item 2.    | Unregistered  Sales of Equity Securities and Use of Proceeds                                |       |
| Item 3.    | Defaults upon  Senior Securities                                                            |       |
| Item 4.    | Submission of  Matters to a Vote of Securities Holders                                      |       |
| Item 5.    | Other Information                                                                           |       |
| Item 6.    | Exhibits                                                                                    |       |
|       | SIGNATURES                                                                                  |       |

 

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**PART I — FINANCIAL INFORMATION**

**Item1.  Financial Statements**

**TRINITY CAPITALCORPORATION & SUBSIDIARIES**

**CONSOLIDATEDBALANCE SHEETS**

**September 30, 2006 andDecember 31, 2005**

**(Amountsin thousands, except share data)**
| ** **                                                                                                                                                                                                                                                                                                                                       | ** ** | **September 30, 2006** | ** ** | **December 31,  2005** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                       | ** ** | **(Unaudited)**                  | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                                                                                                                                                                       |       |                             |       |                        |       |
| Cash and due from banks                                                                                                                                                                                                                                                                                                                          |       | $                                | 21,870     |                        | $          | 24,547 |   |
| Interest bearing deposits with banks                                                                                                                                                                                                                                                                                                             |       | 54,759                           |       | 29,122                      |       |
| Federal funds sold and securities purchased under  resell agreements                                                                                                                                                                                                                                                                             |       | 252                              |       | 1,013                       |       |
| **Cash and cash equivalents**                                                                                                                                                                                                                                                                                                                    |       | $                                | 76,881     |                        | 54,682     |   |
| Investment securities available for sale                                                                                                                                                                                                                                                                                                         |       | 75,664                           |       | 91,231                      |       |
| Investment securities held to maturity, at amortized  cost (fair value of $11,171 at September 30, 2006 and $26,565 at  December 31, 2005)                                                                                                                                                                                             |       | 11,179                           |       | 26,612                      |       |
| Other investments                                                                                                                                                                                                                                                                                                                                |       | 9,302                            |       | 7,965                       |       |
| Loans (net of allowance for loan losses of $11,657  at September 30, 2006 and $8,842 at December 31, 2005)                                                                                                                                                                                                                                  |       | 1,113,173                        |       | 1,010,538                   |       |
| Loans held for sale                                                                                                                                                                                                                                                                                                                              |       | 5,479                            |       | 7,588                       |       |
| Premises and equipment, net                                                                                                                                                                                                                                                                                                                      |       | 23,960                           |       | 24,401                      |       |
| Accrued interest receivable                                                                                                                                                                                                                                                                                                                      |       | 8,462                            |       | 7,321                       |       |
| Mortgage servicing rights, net                                                                                                                                                                                                                                                                                                                   |       | 9,357                            |       | 9,779                       |       |
| Other real estate owned                                                                                                                                                                                                                                                                                                                          |       | 25                               |       | 375                         |       |
| Other assets                                                                                                                                                                                                                                                                                                                                     |       | 3,203                            |       | 3,524                       |       |
| **Total assets**                                                                                                                                                                                                                                                                                                                                 |       | $                                | 1,336,685  |                        | $          | 1,244,016 |   |
|                                                                                                                                                                                                                                                                                                                                             |       |                             |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’ EQUITY**                                                                                                                                                                                                                                                                                                    |       |                             |       |                        |       |
| Liabilities                                                                                                                                                                                                                                                                                                                                      |       |                             |       |                        |       |
| Deposits:                                                                                                                                                                                                                                                                                                                                        |       |                             |       |                        |       |
| Noninterest bearing                                                                                                                                                                                                                                                                                                                              |       | $                                | 94,069     |                        | $          | 79,030 |   |
| Interest bearing                                                                                                                                                                                                                                                                                                                                 |       | 1,032,141                        |       | 962,818                     |       |
| **Total deposits**                                                                                                                                                                                                                                                                                                                               |       | 1,126,210                        |       | 1,041,848                   |       |
| Short-term borrowings                                                                                                                                                                                                                                                                                                                            |       | 12,709                           |       | 10,000                      |       |
| Long-term borrowings                                                                                                                                                                                                                                                                                                                             |       | 63,612                           |       | 72,306                      |       |
| Junior subordinated debt owed to unconsolidated  trusts                                                                                                                                                                                                                                                                                          |       | 43,302                           |       | 32,992                      |       |
| Borrowings made by Employee Stock Ownership Plan  (ESOP) to outside parties                                                                                                                                                                                                                                                                      |       | 743                              |       | 1,214                       |       |
| Accrued interest payable                                                                                                                                                                                                                                                                                                                         |       | 4,530                            |       | 4,047                       |       |
| Other liabilities                                                                                                                                                                                                                                                                                                                                |       | 3,098                            |       | 5,991                       |       |
| **Total liabilities**                                                                                                                                                                                                                                                                                                                            |       | 1,254,204                        |       | 1,168,398                   |       |
| Stock owned by Employee Stock Ownership Plan (ESOP)  participants; 629,245 shares and 614,558 shares at September 30,  2006 and December 31, 2005, respectively, at fair value; net of unearned  ESOP shares of 44,204 and 72,243 shares at September 30, 2006 and  December 31, 2005, respectively, at historical cost |       | 16,279                           |       | 16,100                      |       |
| Commitments and contingencies                                                                                                                                                                                                                                                                                                                    |       |                             |       |                        |       |
| Stockholders’ equity                                                                                                                                                                                                                                                                                                                        |       |                             |       |                        |       |
| Common stock, no par, authorized  20,000,000 shares; issued 6,856,800 shares, shares outstanding  6,589,086 and 6,554,559 at September 30, 2006 and December 31, 2005,  respectively                                                                                                                                              |       | 6,836                            |       | 6,836                       |       |
| Additional paid-in capital                                                                                                                                                                                                                                                                                                                       |       | 951                              |       | 922                         |       |
| Retained earnings                                                                                                                                                                                                                                                                                                                                |       | 64,555                           |       | 58,013                      |       |
| Accumulated other comprehensive (loss)                                                                                                                                                                                                                                                                                                           |       | (247                             | )          | (273                        | )          |
| Total stockholders’ equity before treasury stock                                                                                                                                                                                                                                                                                            |       | 72,095                           |       | 65,498                      |       |
| Treasury stock, at cost, 223,510 shares and 229,998 shares  at September 30, 2006 and December 31, 2005, respectively                                                                                                                                                                                                             |       | (5,893                           | )          | (5,980                      | )          |
| **Total stockholders’ equity**                                                                                                                                                                                                                                                                                                              |       | 66,202                           |       | 59,518                      |       |
| **Total liabilities and stockholders’ equity**                                                                                                                                                                                                                                                                                              |       | $                                | 1,336,685  |                        | $          | 1,244,016 |   |

 

The accompanyingnotes are an integral part of these unaudited consolidated financialstatements.

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**TRINITY CAPITALCORPORATION & SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF INCOME**

**For the Three and Nine Months EndedSeptember 30, 2006 and 2005**

**(Amounts in thousands except shareand per share data)**

**(Unaudited)**
| ** **                                               | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended**  | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|----------------------------------|------------|
| ** **                                               | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| Interest income:                                         |       |                             |       |                             |       |   |   |   |   |
| Loans, including fees                                    |       | $                                | 20,513     |                             | $          | 16,505 |   | $ | 58,128 |   | $ | 46,202 |   |
| Investment securities:                                   |       |                             |       |                             |       |   |   |   |   |
| Taxable                                                  |       | 832                              |       | 495                              |       | 2,732 |   | 1,725 |   |
| Nontaxable                                               |       | 189                              |       | 199                              |       | 591 |   | 558 |   |
| Federal funds sold                                       |       | 6                                |       | 1                                |       | 11 |   | 9 |   |
| Other interest bearing deposits                          |       | 155                              |       | 332                              |       | 308 |   | 431 |   |
| Investment in unconsolidated trusts                      |       | 22                               |       | 22                               |       | 66 |   | 53 |   |
| **Total interest income**                                |       | 21,717                           |       | 17,554                           |       | 61,836 |   | 48,978 |   |
| Interest  expense:                                       |       |                             |       |                             |       |   |   |   |   |
| Deposits                                                 |       | 8,756                            |       | 5,633                            |       | 22,746 |   | 14,375 |   |
| Short-term borrowings                                    |       | 247                              |       | —                           |       | 666 |   | 123 |   |
| Long-term borrowings                                     |       | 623                              |       | 846                              |       | 1,931 |   | 2,249 |   |
| Junior subordinated debt owed to unconsolidated  trusts  |       | 760                              |       | 714                              |       | 2,224 |   | 1,769 |   |
| **Total interest expense**                               |       | 10,386                           |       | 7,193                            |       | 27,567 |   | 18,516 |   |
| **Net  interest income**                                 |       | 11,331                           |       | 10,361                           |       | 34,269 |   | 30,462 |   |
| Provision for  loan losses                               |       | 1,322                            |       | 750                              |       | 4,122 |   | 2,100 |   |
| **Net interest income after provision for loan  losses** |       | 10,009                           |       | 9,611                            |       | 30,147 |   | 28,362 |   |
| Other income:                                            |       |                             |       |                             |       |   |   |   |   |
| Mortgage loan servicing fees                             |       | 662                              |       | 681                              |       | 1,969 |   | 1,942 |   |
| Loan and other fees                                      |       | 732                              |       | 712                              |       | 2,253 |   | 2,009 |   |
| Service charges on deposits                              |       | 386                              |       | 401                              |       | 1,164 |   | 1,100 |   |
| Gain on sale of loans                                    |       | 538                              |       | 665                              |       | 1,429 |   | 1,766 |   |
| Other operating income                                   |       | 458                              |       | 414                              |       | 1,260 |   | 809 |   |
|                                                     |       | 2,776                            |       | 2,873                            |       | 8,075 |   | 7,626 |   |
| Other expenses:                                          |       |                             |       |                             |       |   |   |   |   |
| Salaries and employee benefits                           |       | 4,065                            |       | 4,038                            |       | 12,913 |   | 12,059 |   |
| Occupancy                                                |       | 836                              |       | 785                              |       | 2,521 |   | 2,378 |   |
| Data processing                                          |       | 448                              |       | 486                              |       | 1,343 |   | 1,391 |   |
| Marketing                                                |       | 441                              |       | 403                              |       | 1,382 |   | 1,133 |   |
| Amortization and valuation of mortgage servicing  rights |       | 636                              |       | (162                             | )          | 1,658 |   | 902 |   |
| Supplies                                                 |       | 140                              |       | 159                              |       | 490 |   | 559 |   |
| Loss on sale of other real estate owned                  |       | 8                                |       | 123                              |       | 240 |   | 950 |   |
| Postage                                                  |       | 142                              |       | 142                              |       | 445 |   | 452 |   |
| Other                                                    |       | 1,139                            |       | 931                              |       | 3,589 |   | 3,032 |   |
|                                                     |       | 7,855                            |       | 6,905                            |       | 24,581 |   | 22,856 |   |
| **Income before income taxes**                           |       | 4,930                            |       | 5,579                            |       | 13,641 |   | 13,132 |   |
| Income taxes                                             |       | 1,860                            |       | 2,205                            |       | 5,128 |   | 4,949 |   |
| Net income                                               |       | $                                | 3,070      |                             | $          | 3,374 |   | $ | 8,513 |   | $ | 8,183 |   |
| Basic earnings  per common share                         |       | $                                | 0.47       |                             | $          | 0.51 |   | $ | 1.29 |   | $ | 1.23 |   |
| Diluted earnings per  common share                       |       | $                                | 0.46       |                             | $          | 0.50 |   | $ | 1.29 |   | $ | 1.22 |   |

 

The accompanyingnotes are an integral part of these unaudited consolidated financialstatements.

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**TRINITY CAPITALCORPORATION & SUBSIDIARIES**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**For the Nine Months EndedSeptember 30, 2006 and 2005**

**(Amounts in thousands)**

**(Unaudited)**
| ** **                                                                                  | ** ** | **Nine Months Ended**  | ** ** |
|---------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                  | ** ** | **September 30, 2006** | ** ** | **September 30, 2005** | ** ** |
| ** **                                                                                  | ** ** | ** **                       | ** ** | ** ** | ** ** |
| Cash Flows From  Operating Activities                                                       |       |                             |       |   |   |
| Net income                                                                                  |       | $                                | 8,513      |   | $ | 8,183 |   |
| Adjustments to reconcile net income to net cash  provided by operating activities:          |       |                             |       |   |   |
| Depreciation and amortization                                                               |       | 1,810                            |       | 1,937 |   |
| Net amortization of:                                                                        |       |                             |       |   |   |
| Mortgage servicing rights                                                                   |       | 2,043                            |       | 2,069 |   |
| Premiums and discounts on investment securities                                             |       | (204                             | )          | 722 |   |
| Junior subordinated debt owed to unconsolidated  trusts issuance costs                      |       | 15                               |       | 15 |   |
| Provision for loan losses                                                                   |       | 4,122                            |       | 2,100 |   |
| Recovery of mortgage servicing rights                                                       |       | (385                             | )          | (1,167 | ) |
| Loss on disposal of premises and equipment                                                  |       | 14                               |       | 143 |   |
| Federal Home Loan Bank (FHLB) stock dividends  received                                     |       | (193                             | )          | (146 | ) |
| Gain on sale of loans                                                                       |       | (1,429                           | )          | (1,766 | ) |
| Loss on disposal of other real estate owned                                                 |       | 1                                |       | 157 |   |
| Write-down of value of other real estate owned                                              |       | 40                               |       | 793 |   |
| Increase in other assets                                                                    |       | (671                             | )          | (923 | ) |
| (Decrease) increase in other liabilities                                                    |       | (320                             | )          | 312 |   |
| Release of Employee Stock Ownership Plan (ESOP)  shares                                     |       | 722                              |       | 913 |   |
| Tax benefit recognized for exercise of stock options                                        |       | (331                             | )          | (272 | ) |
| **Net cash provided by operating activities before  originations and gross sales of loans** |       | 13,747                           |       | 13,070 |   |
| Gross sales of loans held for sale                                                          |       | 113,484                          |       | 139,032 |   |
| Origination of loans held for sale                                                          |       | (111,182                         | )          | (145,750 | ) |
| **Net cash provided by operating activities**                                               |       | 16,049                           |       | 6,352 |   |
| Cash Flows From  Investing Activities                                                       |       |                             |       |   |   |
| Proceeds from maturities and paydowns of investment  securities, available for sale         |       | 22,873                           |       | 7,075 |   |
| Proceeds from maturities and paydowns of investment  securities, held to maturity           |       | 15,367                           |       | 28,357 |   |
| Proceeds from maturities and paydowns of investment  securities, other                      |       | —                           |       | 325 |   |
| Purchase of investment securities available for sale                                        |       | (7,008                           | )          | (4,090 | ) |
| Purchase of investment securities other                                                     |       | (1,144                           | )          | (707 | ) |
| Proceeds from sale of other real estate owned                                               |       | 334                              |       | 5,633 |   |
| Loans funded, net of repayments                                                             |       | (106,782                         | )          | (112,268 | ) |
| Purchases of premises and equipment                                                         |       | (1,383                           | )          | (1,430 | ) |
| Proceeds from sale of premises and equipment                                                |       | —                           |       | 100 |   |
| **Net cash (used in) investing activities**                                                 |       | (77,743                          | )          | (77,005 | ) |
| Cash Flows From  Financing Activities                                                       |       |                             |       |   |   |
| Net increase in demand deposits, NOW accounts and  savings accounts                         |       | 16,875                           |       | 36,464 |   |
| Net increase in time deposits                                                               |       | 67,487                           |       | 104,508 |   |
| Proceeds from issuances of borrowings                                                       |       | —                           |       | 30,000 |   |
| Repayment of borrowings                                                                     |       | (5,985                           | )          | (40,145 | ) |
| Repayment of ESOP debt                                                                      |       | (471                             | )          | (472 | ) |
| Proceeds from issuance of trust preferred securities                                        |       | 10,310                           |       | 10,310 |   |
| Purchase of treasury stock                                                                  |       | (1,375                           | )          | (4,422 | ) |
| Issuance of common stock for stock option plan                                              |       | 1,230                            |       | 938 |   |
| Dividend payments                                                                           |       | (4,509                           | )          | (4,057 | ) |
| Tax benefit recognized for exercise of stock options                                        |       | 331                              |       | 272 |   |
| **Net cash provided by financing activities**                                               |       | 83,893                           |       | 133,396 |   |
| **Net increase in cash and cash equivalents**                                               |       | 22,199                           |       | 62,743 |   |
| Cash and cash  equivalents:                                                                 |       |                             |       |   |   |
| Beginning of year                                                                           |       | 54,682                           |       | 23,814 |   |
| End of period                                                                               |       | $                                | 76,881     |   | $ | 86,557 |   |
| Supplemental  Disclosures of Cash Flow Information                                          |       |                             |       |   |   |
| Cash payments for:                                                                          |       |                             |       |   |   |
| Interest                                                                                    |       | $                                | 27,084     |   | $ | 17,916 |   |
| Income taxes                                                                                |       | 4,213                            |       | 5,245 |   |
| Non-cash investing and financing activities:                                                |       |                             |       |   |   |
| Transfers from loans to other real estate owned                                             |       | 25                               |       | 475 |   |
| Dividends declared, not yet paid                                                            |       | —                           |       | 3 |   |
| Change in  unrealized gain on investment securities, net of taxes                           |       | (138                             | )          | (36 | ) |

 

The accompanyingnotes are an integral part of these unaudited consolidated financialstatements.

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**TRINITY CAPITALCORPORATION & SUBSIDIARIESNOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Unaudited)**

**Note 1. Basis of Presentation**

The accompanying unaudited consolidated financialstatements include the consolidated balances and results of operations ofTrinity Capital Corporation (“Trinity”) and its wholly owned subsidiaries: LosAlamos National Bank (the “Bank”), Title Guaranty & Insurance Company (“TitleGuaranty”), TCC Appraisal Services Corporation (“TCC Appraisal”), TCC AdvisorsCorporation (“TCC Advisors”) and TCC Funds, collectively referred to as the “Company.” Trinity Capital Trust I (“Trust I”), Trinity Capital Trust II (“Trust II”),Trinity Capital Trust III (“Trust III”), Trinity Capital Trust IV (“Trust IV”)and Trinity Capital Trust V (“Trust V”), collectively referred to as the “Trusts,”are trust subsidiaries of Trinity but are not consolidated in these financialstatements (see “Consolidation” accounting policy below).  The businessactivities of the Company consist solely of the operations of its wholly ownedsubsidiaries. All significant inter-company balances and transactions have beeneliminated in consolidation.  In the opinion of management, all adjustments(consisting only of normal recurring adjustments) necessary for a fairpresentation of the financial position, results of operations and cash flowsfor the interim periods have been made.  The results of operations for thethree and nine months ended September 30, 2006 are not necessarily indicativeof the results to be expected for the entire fiscal year.

The unaudited consolidatedinterim financial statements have been prepared in conformity with accountingprinciples generally accepted in the United States of America and industrypractice.  Certain information in footnote disclosures normally includedin financial statements prepared in accordance with accounting principles generallyaccepted in the United States of America and industry practice has beencondensed or omitted pursuant to rules and regulations of the Securities andExchange Commission.  These financial statements should be read inconjunction with the consolidated financial statements and notes theretoincluded in the Company’s December 31, 2005 audited financial statements filedon Form 10-K, as amended.

The preparation of financialstatements in conformity with accounting principals generally accepted in the UnitedStates of America requires management to make estimates and assumptions whichaffect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities as of the date of the financial statements,as well as the reported amounts of income and expenses during the reportedperiods.  Actual results could differ from those estimates.

**Note2.  Comprehensive Income**

Comprehensive incomeincludes net income, as well as the change in net unrealized gain on investmentsecurities available for sale, net of tax.  Comprehensive income was $3.3million and $3.4 million for the three month periods ended September 30, 2006and 2005, respectively, and $8.5 million and $8.1 million for the nine monthperiods ended September 30, 2006 and 2005, respectively.

**Note3.  Earnings Per Share Data**

The following table setsforth the computation of basic and diluted earnings per share for the periodsindicated:
| ** **                                                                         | ** ** | **Three Months Ended**                                                                       | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                         | ** ** | **September 30,**                                                                                 | ** ** | **September 30,**          | ** ** |
| ** **                                                                         | ** ** | **2006**                                                                                               | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                         | ** ** | **(Unaudited; in thousands, except share and per share data)** | ** ** |
| Net income                                                                         |       | $                                                                                                      | 3,070      |                            | $          | 3,374 |   | $ | 8,513 |   | $ | 8,183 |   |
| Weighted average  common shares issued                                             |       | 6,856,800                                                                                              |       | 6,856,800                       |       | 6,856,800 |   | 6,856,800 |   |
| LESS: Weighted  average treasury stock shares                                      |       | (227,251                                                                                               | )          | (153,075                        | )          | (227,143 | ) | (142,414 | ) |
| LESS: Weighted  average unearned Employee Stock Ownership Plan (ESOP) stock shares |       | (44,515                                                                                                | )          | (73,348                         | )          | (47,077 | ) | (75,085 | ) |
| Weighted average  common shares outstanding, net                                   |       | 6,585,034                                                                                              |       | 6,630,377                       |       | 6,582,580 |   | 6,639,301 |   |
| Basic earnings  per common share                                                   |       | $                                                                                                      | 0.47       |                            | $          | 0.51 |   | $ | 1.29 |   | $ | 1.23 |   |
| Weighted average  dilutive shares from stock option plan                           |       | 39,572                                                                                                 |       | 59,354                          |       | 38,440 |   | 65,228 |   |
| Weighted average  common shares outstanding including dilutive shares              |       | 6,624,606                                                                                              |       | 6,689,731                       |       | 6,621,020 |   | 6,704,529 |   |
| Diluted earnings per  common share                                                 |       | $                                                                                                      | 0.46       |                            | $          | 0.50 |   | $ | 1.29 |   | $ | 1.22 |   |

 

Certainstock options were not included in the above calculation, according to FAS 128,as these stock options would have an anti-dilutive effect at current marketprices.  The total number of shares thatwere excluded were 211,500 as of September 30, 2006.

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**Note 4. Recent Accounting Pronouncements and Regulatory Developments**

Effective January 1, 2006, we adopted the fair valuerecognition provisions of Statement of Financial Accounting Standards (SFAS)No. 123 (revised 2004), *Share-Based Payment*(SFAS No.123(R)), using the modified prospective transition method and,therefore, have not restated results for prior periods.  Under this transition method, stock-basedcompensation expense for the first nine months of 2006 included compensationexpense for all stock-based compensation awards granted prior to, but not yetvested as of January 1, 2006, based on the grant date fair value estimated inaccordance with the original provision of SFAS No. 123, *Accountingfor Stock-Based Compensation* (SFAS No.123).  Stock-based compensation expense for allstock-based compensation awards granted after January 1, 2006 is based on thegrant-date fair value estimated in accordance with the provisions of SFASNo.123(R).  We recognize thesecompensation costs on a straight-line basis over the requisite service periodof the award.  Prior to the January 1,2006 adoption of SFAS No.123(R), we recognized stock-based compensation expensein accordance with Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees* (APB No. 25).  In March 2005, the Securities and ExchangeCommission (the SEC) issued Staff Accounting Bulletin No. 107 (SAB No. 107)regarding the SEC’s interpretation of SFAS No.123(R) and the valuation ofshare-based payments for public companies. We have applied the provisions of SAB No. 107 in our adoption of SFASNo. 123(R).  We have not modified ouraccount for the Employee Stock Ownership Plan (ESOP), which is accounted for byusing Statement of Position 93-6, *Employers’Accounting for Employee Stock Ownership Plans. *See Note 5 to the Unaudited Consolidated Financial Statementsfor a further discussion on stock-based compensation.  The effect of adopting this standard was toincrease the Company’s expense for the first nine months of 2006 by $196thousand and is expected to increase the Company’s expense for the year endingDecember 31, 2006 by $290 thousand.

In May 2005, the FASB issued SFAS No. 154, *Accounting Changes and Error Corrections*,which provides guidance on the accounting for and reporting of accountingchanges and error corrections. It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition requirementsspecific to the newly adopted accounting principle. The reporting of acorrection of an error by restating previously issued financial statements isalso addressed by this statement. SFAS No. 154 is effective for accountingchanges and corrections of errors made in fiscal years beginning after December15, 2005. Management does not believe that this statement will have a materialimpact on the Company’s financial statements.

In February 2006, the FASB issued SFAS No. 155, *Accounting for Certain Hybrid FinancialInstruments—an amendment of FASB Statements No. 133 and 140*. ThisStatement resolves issues addressed in Statement 133 Implementation Issue No.D1, “Application of Statement 133 to Beneficial Interests in SecuritizedFinancial Assets.”*** ***This Statement eliminates the exemption from applying Statement133 to interests in securitized financial assets so that similar instrumentsare accounted for similarly regardless of the form of the instruments. ThisStatement also improves financial reporting by allowing a preparer to electfair value measurement at acquisition, at issuance, or when a previouslyrecognized financial instrument is subject to a re-measurement (new basis) event,on an instrument-by-instrument basis, in cases in which a derivative wouldotherwise have to be bifurcated. Providing a fair value measurement electionalso results in more financial instruments being measured at what the Boardregards as the most relevant attribute for financial instruments, fair value.This Statement is effective for all financial instruments acquired or issuedafter the beginning of an entity’s first fiscal year that begins afterSeptember 15, 2006. Management does not believe that this statement will have amaterial impact on the Company’s financial statements.

In March 2006, the FASB issued SFAS No. 156, *Accounting for Servicing of Financial Assets*.The new Standard, which is an amendment to SFAS No. 140, **Accounting forTransfers and Servicing of Financial Assets and Extinguishments ofLiabilities-a replacement of FASB Statement No. 125**, willsimplify the accounting for servicing assets and liabilities, such as thosecommon with mortgage securitization activities. Specifically, the new Standard addresses the recognition and measurementof separately recognized servicing assets and liabilities and provides anapproach to simplify efforts to obtain hedge-like (offset) accounting.  The standard also: (1) clarifies when an obligation to servicefinancial assets should be separately recognized as a servicing asset or aservicing liability; (2) requires that a separately recognized servicing assetor servicing liability be initially measured at fair value, if practicable; (3)permits an entity with a separately recognized servicing asset or servicingliability to choose either the amortization method or the fair value method forsubsequent measurement.  SFAS No.156 permits a servicer that uses derivative financial instruments to offsetrisks on servicing to report both the derivative financial instrument andrelated servicing asset or liability by using a consistent measurementattribute – fair value.  This Statementis effective for all financial instruments acquired or issued after the beginningof an entity’s first fiscal year that begins after September 15, 2006.  Management has determined that the Companywill not adopt the fair value method for subsequent measurement under thisstandard.

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In June 2005, the FASBissued Interpretation 48, *Accounting for Uncertaintyin Income Taxes—an interpretation of FASB Statement No. 109.*  This Interpretation clarifies the accountingfor uncertainty in income taxes recognized in an enterprise’s financialstatements in accordance with FASB Statement No. 109, *Accounting for Income Taxes.* ThisInterpretation prescribes a recognition threshold and measurement attribute forthe financial statement recognition and measurement of a tax position taken orexpected to be taken in a tax return. This Interpretation also providesguidance on derecognition, classification, interest and penalties, accountingin interim periods, disclosure, and transition. This Interpretation is effective for fiscal years beginning afterDecember 15, 2006. Earlier application of the provisions of this Interpretationis encouraged if the enterprise has not yet issued financial statements,including interim financial statements, in the period this Interpretation isadopted.  Management does not believe thatadoption of this Interpretation will have a material impact on the Company’sfinancial statements.

The Financial Services Regulatory Relief Act of 2006(the “Regulatory Relief Act”) was signed into law on October 13, 2006.  The stated purpose of the Regulatory ReliefAct is to provide regulatory relief and improve productivity for insureddepository institutions. Among other things, the Regulatory Relief Act: (i) requires theSecurities and Exchange Commission and the Board of Governors of the FederalReserve System, in consultation with the other federal banking regulators, tojointly promulgate regulations to implement the bank broker-dealer exceptionsenacted in the Gramm-Leach-Bliley Act, and makes savings associations subjectto the same broker-dealer registration requirements as banks; (ii) authorizesthe Federal Reserve to pay interest on reserve balances maintained at theFederal Reserve Banks; (iii) authorizes the Federal Reserve to lower thereserve requirement for transaction accounts to 0%; (iv) enhances the authorityof a national bank or state member bank to make community developmentinvestments and increases (from 10% to 15%) the maximum amount of unimpairedcapital and surplus that a national bank or member bank may invest ininvestments designed to promote the public welfare; (v) increases the assetthreshold (from $250 million to $500 million) for well-capitalized andwell-managed banks eligible for 18-month (rather than 12-month) examinations;(vi) enhances the  power of the federalbanking agencies to enforce conditions imposed in writing in connection withthe approval of applications and written agreements; (vii) clarifies thejurisdiction of the various state regulators over banks with branches in morethan one state; and (viii) directs the Comptroller General to conduct studieson the currency transaction report filing system to determine whether and towhat extent the filing rules for currency transaction reports are burdensomeand whether such requirements should be modified to reduce such perceivedburdens.

**Note 5.  StockOption Plan**

The Company’s 1998 Stock Option Plan and 2005 StockIncentive Plan were created for the benefit of key management and selectemployees. Under the 1998 Stock Option Plan, 400,000 shares (as adjustedfor the stock split of December 19, 2002) from shares held in treasury orauthorized but unissued common stock are reserved for granting options. Underthe 2005 Stock Incentive Plan, 500,000 shares from shares held in treasury orauthorized but unissued common stock are reserved for granting stock-basedincentive awards.  Both of these planswere approved by the Company’s shareholders. The Board of Directors determines vesting and pricing of the awards. Allstock options granted through December 31, 2005 were granted at or abovethe fair value of the stock at the date of the grant, vest over three years andmust be exercised within ten years of the date of grant.  Stock appreciation rights granted afterDecember 31, 2005 were also granted at or above the fair value of the stock atthe date of the grant and mature at five years.

Effective January 1, 2006, the Company adopted SFASNo. 123(R), *Share-Based Payment*, which is anAmendment of FASB Statement Nos. 123 and 95. The Company adopted this standard using the modified prospectivetransition method.  Prior to the adoptionof SFAS 123(R), the Company measured stock-based compensation cost inaccordance with the methods prescribed in Accounting Principles Board (APB)Opinion No. 25, *Accounting for Stock Issued to Employees*.  Accordingly, no compensation cost wasrecognized for options granted and vested before January 1, 2006.

Under the provisions of SFAS 123(R), the Company isrequired to recognize compensation expense for share-based compensation thatvest after adoption of the new standard. The Company uses the Black-Sholes model to value the stock options andstock appreciation rights on the date of the grant, and recognizes this expenseover the remaining vesting term for the stock options or stock appreciationrights.  Key assumptions used in thisvaluation method (detailed below) are the volatility of the Company’s stockprice, a risk-free rate of return (using the U.S. Treasury yield curve) basedon the expected term from grant date to exercise date and an annual dividendrate based upon the current market price. Expected term from grant date is based upon the historical time fromgrant to exercise experienced by the Company. Because share-based compensation vesting in the current periods weregranted on a variety of dates, the assumptions are presented as ranges in thoseassumptions.

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The following table details the assumptions used inthe Black-Sholes model for share-based compensation granted:
| ** **                | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|---------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                | ** ** | **2006**                                                 | ** ** | **2005**                                                | ** ** | **2006** | ** ** | **2005** | ** ** |
|                      |       |                                                     |       |                                                    |       |   |   |   |   |
| Stock price  volatility   |       | —                                                   |       | 14.12                                                   | %          | 14.12 | % | 14.12 | % |
| Risk-free rate            |       | —                                                   |       | 4.23                                                    | %          | 4.35 | % | 4.23 | % |
| Expected  dividends       |       | —                                                   |       | 2.29                                                    | %          | 2.29 | % | 2.29 | % |
| Expected term (in  years) |       | —                                                   |       | 10                                                      |       | 5 |   | 10 |   |

 

A summary of stock option and stock appreciation rightactivity under the plans as of September 30, 2006, and changes during the firstnine months of the year is presented below:
| ** **                          | ** ** | **Shares** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Weighted-Average  Remaining Contractual  Term, in years** | ** ** | **Aggregate Intrinsic  Value (in thousands)** | ** ** |
|-------------------------------------|------------|------------|------------|-------------------------------------------|------------|----------------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
|                                | ** ** | ** ** | ** ** | ** **                                | ** ** | ** **                                                                 | ** ** | ** **                                                   | ** ** |
| Outstanding at  January 1, 2006     |       | 333,117    |       | $                                         | 23.15      |                                                                       |       |                                                         |       |   |
| Granted                             |       | 84,000     |       | 28.00                                     |       |                                                                       |       |                                                         |       |
| Exercised                           |       | (56,209    | )          | 12.51                                     |       |                                                                       |       |                                                         |       |
| Forfeited or  expired               |       | (3,500     | )          | 28.00                                     |       |                                                                       |       |                                                         |       |
| Outstanding at  September 30, 2006  |       | 357,408    |       | $                                         | 25.92      |                                                                       | 5.89       |                                                         | $          | 1,573 |   |
| Exerciseable at September  30, 2006 |       | 209,907    |       | $                                         | 23.51      |                                                                       | 5.78       |                                                         | $          | 880 |   |

 

There were no options granted during the three monthsending September 30, 2006.  Theweighted-average grant-date fair value of options granted during the ninemonths ending September 30, 2006 was $4.33. The total intrinsic value of options exercised during the nine monthsended September 30, 2006 was $168 thousand.

As of September 30, 2006, there was $693 thousand oftotal unrecognized compensation cost related to nonvested share-basedcompensation arrangements granted under the plans.  That cost is expected to be recognized over aweighted-average vesting period of 2.9 years. There were 14,000 shares vested during the nine months ending September30, 2006.  Additional shares that willvest in December, 2006 have been ratably expensed.  The total amount expensed of both the sharesthat have vested and will vest that have been ratably expensed is $49 thousandin the third quarter and $196 thousand in the first nine months of 2006.

The following pro forma information presents netincome and earnings per share had the fair value method of SFAS No. 123 beenused to measure compensation cost for stock option plans in the third quarterand first nine months of 2005.
|                                                                                                                                               | ** ** | **Three Months  Ended  September 30,  2005**            | ** ** | **Nine Months  Ended September  30, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                                                                                                    | ** ** | **(In thousands, except per share  amounts)** | ** ** |
| Net income as  reported                                                                                                                       |       | $                                                                 | 3,374      |                                                 | $          | 8,183 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related tax effects |       | 57                                                                |       | 114                                                  |       |
| Pro forma net  income                                                                                                                         |       | $                                                                 | 3,317      |                                                 | $          | 8,069 |   |
| Earnings per  share:                                                                                                                          |       |                                                              |       |                                                 |       |
| Basic — as  reported                                                                                                                     |       | $                                                                 | 0.51       |                                                 | $          | 1.23 |   |
| Basic — pro  forma                                                                                                                       |       | $                                                                 | 0.50       |                                                 | $          | 1.22 |   |
| Diluted — as  reported                                                                                                                   |       | $                                                                 | 0.50       |                                                 | $          | 1.22 |   |
| Diluted — pro forma                                                                                                                      |       | $                                                                 | 0.50       |                                                 | $          | 1.20 |   |

 

**Note6.  Short Term Borrowings**

The Company had Federal Home Loan Bank advances withmaturity dates of less than one year of $12.7 million and $10.0 million as ofSeptember 30, 2006 and December 31, 2005, respectively.

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**Note 7.  Long Term Borrowings**

The Company had FederalHome Loan Bank advances with maturity dates greater than one year of $63.6million and $72.3 million as of September 30, 2006 and December 31, 2005,respectively.  As of September 30, 2006, the advances had fixed interestrates ranging from 3.22% to 6.34%.

**Note 8. Junior Subordinated Debt Owed to Unconsolidated Trusts**

The following table presents details on the juniorsubordinated debt owed to unconsolidated trusts as of September 30, 2006:
| ** **                                                  | ** ** | **Trust I**                     | ** ** | **Trust II**      | ** ** | **Trust III**     | ** ** | **Trust IV**      | ** ** | **Trust V**   | ** ** |
|-------------------------------------------------------------|------------|--------------------------------------|------------|------------------------|------------|------------------------|------------|------------------------|------------|--------------------|------------|
| ** **                                                  | ** ** | **(Dollars in thousands)** | ** ** |
| Date of issue                                               |       | March 23, 2000                  |       | November 28, 2001 |       | May 11, 2004      |       | June 29, 2005     |       | September 21, 2006 |       |
| Amount of trust  preferred securities issued                |       | $                                    | 10,000     |                   | $          | 6,000                  |       | $                      | 6,000      |               | $          | 10,000 |   | $ | 10,000 |   |
| Rate on trust  preferred securities                         |       | 10.875                               | %          | 9.95                   | %          | 8.10% (variable        | )          | 6.88                   | %          | 6.83               | %          |
| Maturity                                                    |       | March 8, 2030                   |       | December 8, 2031  |       | September 8, 2034 |       | November 23, 2035 |       | December 15, 2036  |       |
| Date of first  redemption                                   |       | March 8, 2010                   |       | December 8, 2006  |       | September 8, 2009 |       | August 23, 2010   |       | September 15, 2011 |       |
| Common equity  securities issued                            |       | $                                    | 310        |                   | $          | 186                    |       | $                      | 186        |               | $          | 310 |   | $ | 310 |   |
| Junior  subordinated deferrable interest debentures owed    |       | $                                    | 10,310     |                   | $          | 6,186                  |       | $                      | 6,186      |               | $          | 10,310 |   | $ | 10,310 |   |
| Rate on junior  subordinated deferrable interest debentures |       | 10.875                               | %          | 9.95                   | %          | 8.10% (variable        | )          | 6.88                   | %          | 6.83               | %          |

 

On the dates of issue indicated above, the Trusts,being Delaware statutory business trusts, issued trust preferred securities(the “trust preferred securities”) in the amount and at the rate indicatedabove.  These securities represent preferred beneficial interests in theassets of the Trusts.  The trust preferred securities will mature on thedates indicated, and are redeemable in whole or in part at the option of theCompany at any time after the date of first redemption indicated above, withthe approval of the Federal Reserve Board and in whole at any time upon theoccurrence of certain events affecting their tax or regulatory capitaltreatment.  The Trusts also issued common equity securities to Trinity in theamounts indicated above.  The Trusts used the proceeds of the offering ofthe trust preferred securities to purchase junior subordinated deferrableinterest debentures (the “debentures”) issued by the Company, which have termssubstantially similar to the trust preferred securities.  The Company hasthe right to defer payments of interest on the debentures at any time or fromtime to time for a period of up to ten consecutive semi-annual periods withrespect to each interest payment deferred.  Under the terms of thedebentures, under certain circumstances of default or if the Company haselected to defer interest on the debentures, the Company may not, with certainexceptions, declare or pay any dividends or distributions on its capital stockor purchase or acquire any of its capital stock.  The Company used themajority of the proceeds from the sale of the debentures to add to Tier 1 orTier 2 capital in order to support its growth and to purchase treasury stock.

Trinity owns all of the outstanding common securitiesof the Trusts.  The Trusts are considered variable interest entities(VIEs) under *Financial Accounting StandardsBoard Interpretation (FIN) No. 46, “Consolidation of Variable InterestEntities, an interpretation of Accounting Research Bulletin No. 51”*,as revised.  Prior to FIN 46, VIEs were generally consolidated by anenterprise when the enterprise had a controlling financial interest throughownership of a majority of voting interest in the entity.  Under FIN 46, aVIE should be consolidated by its primary beneficiary.  The Companyimplemented FIN 46 during the fourth quarter of 2003.  Because Trinity isnot the primary beneficiary of the Trusts, the financial statements of theTrusts are no longer included in the consolidated financial statements of theCompany.  The Company’s prior financial statements have been reclassifiedto de-consolidate the Company’s investment in the Trusts.

In March 2005, theBoard of Governors of the Federal Reserve System issued a finalrule allowing bank holding companies to continue to include qualifyingtrust preferred securities in their Tier 1 Capital for regulatory capitalpurposes, subject to a 25% limitation to all core (Tier I) capital elements,net of goodwill less any associated deferred tax liability.  The finalrule provides a five-year transition period, ending March 31, 2009,for application of the aforementioned quantitative limitation.  As ofSeptember 30, 2006, 65.5% of the trust preferred securities noted in the tableabove qualified as Tier I capital and 34.5% qualified as Tier 2 capital underthe final rule adopted in March 2005.

Payments of distributions on the trust preferredsecurities and payments on redemption of the trust preferred securities areguaranteed by the Company on a limited basis.  The Company also enteredinto an agreement as to expenses and liabilities with the Trusts pursuant towhich it agreed, on a subordinated basis, to pay any costs, expenses orliabilities of the Trusts other than those arising under the trust preferredsecurities.  The obligations of the Company under the junior subordinateddebentures, the related indenture, the trust agreement establishing the Trusts,the guarantee and the agreement as to expenses and liabilities, in theaggregate, constitute a full and unconditional guarantee by the Company of theTrusts’ obligations under the trust preferred securities.

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Issuance costs of $615 thousand related to the firstthree trust preferred securities issues were deferred and are being amortizedover the period until mandatory redemption of the securities inMarch 2030, December 2031 and September 2034,respectively.  During each of the three month periods endedSeptember 30, 2006 and 2005, $5 thousand of these issuance costs wereamortized.  During each of the nine month periods ended September 30,2006 and 2005, $15 thousand of these issuance costs were amortized. Unamortized issuance costs were $503 thousand and $519 thousand atSeptember 30, 2006 and December 31, 2005, respectively.  Therewere no issuance costs associated with the fourth or fifth trust preferredsecurity issues.

Dividends accrued andunpaid to securities holders totaled $388 thousand and $364 thousand onSeptember 30, 2006 and 2005, respectively.

**Note 9. Commitments, Contingencies and Off-Balance Sheet Activities**

*Credit-relatedfinancial instruments:*  The Company is a party tocredit-related commitments with off-balance-sheet risk in the normal course ofbusiness to meet the financing needs of its customers.  Thesecredit-related commitments include commitments to extend credit, standbyletters of credit and commercial letters of credit.  Such credit-relatedcommitments involve, to varying degrees, elements of credit and interest raterisk in excess of the amount recognized in the consolidated balance sheets.

The Company’s exposure tocredit loss is represented by the contractual amount of these credit-relatedcommitments.  The Company follows the same credit policies in makingcredit-related commitments as it does for on-balance-sheet instruments.

At September 30, 2006 andDecember 31, 2005, the following credit-related commitments wereoutstanding whose contract amounts represent credit risk:
|                                             | ** ** | **Contract Amount**     | ** ** |
|---------------------------------------------|------------|------------------------------|------------|
| ** **                                  | ** ** | **September 30,  2006** | ** ** | **December  31, 2005** | ** ** |
| ** **                                  | ** ** | **(In thousands)**      | ** ** |
| Unfunded  commitments under lines of credit |       | $                            | 205,217    |   | $ | 182,641 |   |
| Commercial and standby  letters of credit   |       | 34,469                       |       | 37,436 |   |
|                                             |            |                              |            |  |  |  |  |

 

Commitments to extendcredit are agreements to lend to a customer as long as there is no violation ofany condition established in the contract.  Commitments generally havefixed expiration dates or other termination clauses and may require a paymentof a fee.  The commitments for equity lines of credit may expire withoutbeing drawn upon.  Therefore, the total commitment amounts do notnecessarily represent future cash requirements.  The amount of collateralobtained, if it is deemed necessary by the Company, is based on management’scredit evaluation of the customer.  Unfunded commitments under commerciallines of credit, revolving credit lines and overdraft protection agreements arecommitments for possible future extensions of credit to existingcustomers.  Overdraft protection agreements are uncollateralized, but mostother unfunded commitments have collateral.  These overdraft protectionunfunded lines of credit usually do not contain a specified maturity date andmay not necessarily be drawn upon to the total extent to which the Company iscommitted.

Commercial and standbyletters of credit are conditional credit-related commitments issued by theCompany to guarantee the performance by the customer to a third party. Those letters of credit are primarily issued to support public and privateborrowing arrangements.  Essentially all letters of credit issued haveexpiration dates within one year. The credit risk involved in issuing lettersof credit is the same as that involved in extending loans to customers. The Company generally holds collateral supporting those credit-relatedcommitments. In the event the customer does not perform in accordance with theterms of the agreement with the third party, the Company would be required tofund the credit-related commitment.  The maximum potential amount offuture payments the Company could be required to make is represented by the contractualamount shown in the summary above.  If the credit-related commitment isfunded, the Company would be entitled to seek recovery from the customer. At September 30, 2006 and December 31, 2005, no amounts have beenrecorded as liabilities for the Company’s potential obligations under thesecredit-related commitments.  The fair value of these credit-relatedcommitments is approximately equal to the fees collected when granting theseletters of credit.  These fees collected were $77 thousand and $33thousand as of September 30, 2006 and December 31, 2005,respectively, and are included in “other liabilities” on the Company’s balancesheets.

*Concentrationsof credit risk:*  The majority of the loans, commitmentsto extend credit, and standby letters of credit have been granted to customersin Los Alamos and surrounding communities.  Although the Company has adiversified loan portfolio, a substantial portion of its loans are made tobusinesses and individuals associated with, or employed by, Los Alamos NationalLaboratory (“the Laboratory”).  The ability of such borrowers to honortheir contracts is predominately dependent upon the continued operation andfunding of the Laboratory.  Investments in securities issued by states andpolitical subdivisions involve governmental entities within the State of NewMexico.  The distribution of types of commitments to extend creditapproximates the distribution of loans outstanding.  Standby letters ofcredit were granted primarily to commercial borrowers.

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*Contingencies:* In the normal course of business, the Company is involved in various legalproceedings.  In the opinion of management, after consulting with counsel,probable liabilities resulting from such proceedings would not have a materialadverse effect on the Company’s consolidated financial statements.

**Item2.  Management’s Discussion and Analysis of Financial Condition andResults of Operations**

*This discussion is intended to focus on certain financialinformation regarding the Company and its subsidiaries and is written toprovide the reader with a more thorough understanding of its financialstatements. The following discussion and analysis of the Company’s financialposition and results of operations should be read in conjunction with theinformation set forth in Item 3, Quantitative and Qualitative Disclosuresabout Market Risk and the annual audited consolidated financial statementsfiled on Form 10-K, as amended.*

**Special Note ConcerningForward-Looking Statements**

This document(including information incorporated by reference) contains, and future oral andwritten statements of the Company and its management may contain,forward-looking statements, within the meaning of such term in the PrivateSecurities Litigation Reform Act of 1995, with respect to the financialcondition, results of operations, plans, objectives, future performance andbusiness of the Company. Forward-looking statements, which may be based uponbeliefs, expectations and assumptions of the Company’s management and oninformation currently available to management, are generally identifiable bythe use of words such as “believe,” “expect,” “anticipate,” “plan,” “intend,” “estimate,”“may,” “will,” “would,” “could,” “should” or other similar expressions.Additionally, all statements in this document, including forward-lookingstatements, speak only as of the date they are made, and the Company undertakesno obligation to update any statement in light of new information or futureevents.

Our ability to predict results or the actual effect offuture plans or strategies is inherently uncertain. The factors, which couldhave a material adverse effect on our operations and future prospects aredetailed in the “Risk Factors” section included under Item 1a. of Part I of ourForm 10-K. In addition to the risk factors described in that section, there areother factors that may impact any public company, including ours, which couldhave a material adverse effect on our operations and future prospects. Theserisks and uncertainties should be considered in evaluating forward-lookingstatements and undue reliance should not be placed on such statements.

**Critical Accounting Policies**

***Allowance for Loan Losses:***  Theallowance for loan losses is that amount which, in management’s judgment, isconsidered appropriate to provide for potential losses in the loan portfolio.In analyzing the adequacy of the allowance for loan losses, management uses acomprehensive loan grading system to determine risk potential in the portfolio,and considers the results of periodic internal and external loan reviews.Historical loss experience factors and specific reserves for impaired loans,combined with other considerations, such as delinquency, non-accrual,criticized and classified loan trends, economic conditions, concentrations ofcredit risk, and experience and abilities of lending personnel, are alsoconsidered in analyzing the adequacy of the allowance. Management uses asystematic methodology, which is applied at least quarterly, to determine theamount of allowance for loan losses and the resultant provisions for loanlosses it considers adequate to provide for anticipated loan losses. Thismethodology includes a periodic detailed analysis of the loan portfolio, asystematic loan grading system and a periodic review of the summary of theallowance for loan and lease loss balance. In the event that different assumptions or conditions were to prevail,and depending upon the severity of such changes, the possibility of materiallydifferent financial condition or results of operations is a reasonablelikelihood.

Management recently completed a review of themethodology used in the allowance for loan losses adequacy analysis.  After a thorough examination, managementrefined the process used in two ways: (1) we moved from a pure historical lossto a migration analysis for determining inherent loss in the current loanportfolio and (2) we quantified the qualitative adjustments used to reflect therisks associated with certain risk factors that are not reflected in themigration analysis or specific identification of impaired loans.

Accordingly, three methods are used to evaluate theadequacy of the allowance for loan losses: (1) specific identification, basedon management’s assessment of loans in our portfolio and the probability that acharge-off will occur in the upcoming quarter, per SFAS 114; (2) lossesinherent in the loan portfolio besides those specifically identified, basedupon a migration analysis of the percentage of loans currently performing thathave inherent losses, per SFAS 5; and (3) qualitative adjustments based onmanagement’s assessment of certain risks such as delinquency trends, watch-listand classified trends, changes in concentrations, economic trends, industrytrends, non-accrual trends, exceptions and loan-to-value guidelines, managementand staff changes and policy or procedure changes (also per SFAS 5).

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While management uses the best information availableto make its evaluation, future adjustments to the allowance may be necessary ifthere are significant changes in economic conditions.  In addition, as an integral part of theirexamination process regulatory agencies periodically review our allowance forloan losses and may require us to make additions to the allowance based ontheir evaluation of information available at the time of their examinations.

***Mortgage ServicingRight (MSR) Assets:***  Servicing residential mortgageloans for third-party investors represents a significant business activity ofthe Bank. As of September 30, 2006, mortgage loans serviced for others totaled$957.8 million. The MSRs on these loans total $9.4 million as of September 30,2006. The expected and actual rates of mortgage loan prepayments are the mostsignificant factors driving the value of MSRs. Increases in mortgage loanprepayments reduce estimated future net servicing cash flows because the lifeof the underlying loan is reduced. In determining the fair value of the MSRs,mortgage interest rates, which are used to determine prepayment rates anddiscount rates are held constant over the estimated life of the portfolio. Fairvalues of the MSRs are provided by an independent third-party broker of MSRs ona monthly basis. The values given by the broker are based upon current marketconditions and assumptions, which incorporate the expected life of the loans,estimated costs to service the loans, servicing fees to be received and otherfactors. MSRs are carried at the lower of the initial capitalized amount, netof accumulated amortization, or fair value.

The fair value of the MSRs is driven primarily by the effect current mortgage interest rates have on the likelihood borrowers will prepay the underlying mortgages by refinancing at a lower rate.  Accordingly, higher interest rates decrease the likelihood of repayment, extending the life of the MSRs and increasing the value of these assets.  Lower interest rates increase the likelihood of repayment, contracting the life of the MSRs and decreasing the value of these assets.  This can have a significant impact on our income.  There is no certainty on the direction and amount of interest rate changes looking forward, and therefore, there is no certainty on the amount or direction of the change in valuation.

An analysis of changes inmortgage servicing rights asset follows:
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(In thousands)**          | ** ** |
| Balance at beginning of  period              |       | $                                | 10,460     |                            | $          | 11,334 |   | $ | 11,009 |   | $ | 11,859 |   |
| Servicing rights  originated and capitalized |       | 429                              |       | 597                             |       | 1,236 |   | 1,452 |   |
| Amortization                                 |       | (687                             | )          | (689                            | )          | (2,043 | ) | (2,069 | ) |
|                                         |       | $                                | 10,202     |                            | $          | 11,242 |   | $ | 10,202 |   | $ | 11,242 |   |

 

Below is an analysis of changesin the mortgage servicing right asset valuation allowance:
| ** **                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
| ** **                                   | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                   | ** ** | **(In thousands)**          | ** ** |
| Balance at  beginning of period              |       | $                                | (896       | )                               | $          | (3,172 | ) | $ | (1,230 | ) | $ | (3,488 | ) |
| Aggregate  reductions credited to operations |       | 57                               |       | 969                             |       | 391 |   | 2,154 |   |
| Aggregate  additions charged to operations   |       | (6                               | )          | (118                            | )          | (6 | ) | (987 | ) |
|                                         |       | $                                | (845       | )                               | $          | (2,321 | ) | $ | (845 | ) | $ | (2,321 | ) |

 

The fair values of the MSRs were$10.1 million, $10.5 million and $9.9 million on September 30, 2006, December31, 2005 and September 30, 2005, respectively.

The primary risk characteristics of the underlyingloans used to stratify the servicing assets for the purposes of measuringimpairment are interest rate and original term.

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Our valuation allowance is used to recognizeimpairments of our MSRs.  An MSR isconsidered impaired when the market value of the MSR is below the amortizedbook value of the MSR.  The MSRs areaccounted by risk tranche, with the interest rate and term of the underlyingloan being the primary strata used in distinguishing the tranches.  Each tranche is evaluated separately forimpairment.

We have an independent third party analyze our MSRsfor impairment on a monthly basis.  Thisindependent third party analyzes the underlying loans on all serviced loansand, based upon their knowledge of the value of MSRs that are traded on theopen market, they assign a current market value for each risk tranche in ourportfolio.  We then compare that marketvalue to the current amortized book value for each tranche.  The change in market value (up to theamortized value of the MSR) is recorded as an adjustment to the MSR valuationallowance, with the offset being recorded as an addition or a reduction toincome.

The independent third party usedthe following assumptions to calculate the market value of the MSRs as ofSeptember 30, 2006, December 31, 2005 and September 30, 2005:
|                                             | ** ** | **At September 30,  2006** | ** ** | **At December 31,  2005** | ** ** | **At September 30,  2005** | ** ** |
|---------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| ** **                                  | ** ** | ** **                           | ** ** | ** **                          | ** ** | ** **                           | ** ** |
| Prepayment  Standard Assumption (PSA) speed |       | 169.00                               | %          | 165.00                              | %          | 190.00                               | %          |
| Discount rate                               |       | 10.00                                |       | 9.01                                |       | 9.03                                 |       |
| Earnings rate                               |       | 5.00                                 |       | 4.00                                |       | 4.00                                 |       |
|                                        |       |                                 |       |                                |       |                                 |       |

 

**Overview**

The Company’s net income slightly decreased from thesecond quarter of 2006 to the third quarter of 2006.  Net income decreased$272 thousand (8.1%) in the third quarter of 2006 compared to the secondquarter of 2006.  The Company’s net income also decreased $304 thousand(9.0%) from the third quarter of 2005 to the third quarter of 2006.  Thisdecrease was primarily due to an increase in non-interest expense and anincrease in the provision for loan losses.  Total assets grew $92.7million (7.4%) from December 31, 2005 to September 30, 2006.  Net income for the nine months endedSeptember 30, 2006 increased by $330 thousand (4.0%) over the same period in2005.  This increase was primarily due to an increase in net interest income,which was partially offset by an increase in the provision for loanlosses.  The increase in net interestincome was due to an increase in both the yield and the volume of theinterest-earning assets of LANB.

**Income Statement Analysis**

***Net Income-General.***  Net incomefor the third quarter of 2006 totaled $3.070 million or $0.46 diluted earningsper share, compared to $3.374 million or $0.50 diluted earnings per share forthe same period in 2005, a decrease of $304 thousand in net income and adecrease of $0.04 in diluted earnings per share.  This represented a decrease in dilutedearnings per share of 8.0%.  Thisdecrease in net income was primarily due to an increase in non-interest expenseof $950 thousand and an increase in provision for loan losses of $572thousand.  The increase in non-interestexpense was mainly due to a decrease in the recovery of the valuation allowanceassociated with mortgage servicing rights. The increase in the provision for loan losses was due to an increasedprovision indicated by the reserve for loan loss analysis.  This increase was due to refining some of themethodologies used in the reserve for loan loss analysis, as stated above (see “CriticalAccounting Policies—Allowance for Loan Losses”).  In addition, net interest income increased$970 thousand and non-interest income decreased by $97 thousand. The increasein net interest income was due to an increase in both the yield and the volumeof the interest-earning assets of LANB, which was partially offset by increasesin the cost and volume of interest-bearing liabilities.  Income tax expenses decreased $345 thousanddue to lower pre-tax income.

Net income for thefirst nine months of 2006 totaled $8.513 million or $1.29 diluted earnings pershare, compared to $8.183 million or $1.22 diluted earnings per share for thesame period in 2005, an increase of $330 thousand in net income and an increaseof $0.07 in diluted earnings per share. This represented an increase in diluted earnings per share of 5.7%.  This increase in net income was primarily dueto an increase in net interest income of $3.807 million, which was partiallyoffset by an increase in the provision for loan losses of $2.022 million.  The increase in net interest income was dueto an increase in both the yield and the volume of the interest-earning assetsof LANB, which was partially offset by increases in the cost and volume ofinterest-bearing liabilities.  Theincrease in the provision for loan losses was largely due to a provisionassociated with a single loan to a commercial borrower and an increase in theprovision indicated by the reserve for loan loss analysis.  This increase was due to refining some of themethodologies used in the reserve for loan loss analysis, as stated above (see “CriticalAccounting Policies—Allowance for Loan Losses”).  In addition, non-interest expense increasedby $1.725 million and non-interest income increased $449 thousand.  The increase in non-interest expense wasprimarily due to an increase in salaries and employee benefits and a decreasein the recovery of the valuation allowance associated with mortgage servicingrights.  Income tax expenses increased$179 thousand due to higher pre-tax income.

12

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The profitability of the Company’s operations dependsprimarily on its net interest income, which is the difference between totalinterest earned on interest-earning assets and total interest paid oninterest-bearing liabilities. The Company’s net income is affected by itsprovision for loan losses as well as other income and other expenses. Theprovision for loan losses reflects the amount thought to be adequate to coverprobable credit losses in the loan portfolio. Non-interest income or otherincome consists of mortgage loan servicing fees, loan and other fees, servicecharges on deposits, gain on sale of loans, gain on sale of securities andother operating income. Other expenses include salaries and employee benefits,occupancy expenses, data processing expenses, marketing, amortization andvaluation of mortgage servicing rights, supplies expense and other expenses.

The amount of net interest income is affected bychanges in the volume and mix of interest-earning assets, the level of interestrates earned on those assets, the volume and mix of interest-bearingliabilities, and the level of interest rates paid on those interest-bearingliabilities. The provision for loan losses is dependent on changes in the loanportfolio and management’s assessment of the collectibility of the loanportfolio, as well as economic and market conditions, which is discussed inmore detail in “Critical Accounting Policies—Allowance for Loan Losses”.  Other income and other expenses are impactedby growth of operations and growth in the number of accounts through corebanking business growth.  Growth in operations affects other expenses as aresult of additional employees, branch facilities and promotional marketingexpense. Growth in the number of accounts affects other income includingservice fees as well as other expenses such as computer services, supplies,loss (gain) on sale of other real estate owned, postage, telecommunications andother miscellaneous expenses.

13

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***Net Interest Income.***  Thefollowing tables present, for the periods indicated, the total dollar amount ofinterest income from average interest-earning assets and the resultant yields,as well as the interest expense on average interest-bearing liabilities, andthe resultant costs, expressed both in dollars and rates:
| ** **                                                                   | ** ** | **Three Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                                 | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **Average**                                              | ** ** | ** ** | ** ** | ** ** | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **Balance**                                              | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** |
| ** **                                                                   | ** ** | **(Dollars in thousands)**                     | ** ** |
| **Interest-Earning  Assets:**                                                |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Loans(1)(2)                                                                  |       | $                                                        | 1,115,681  |   | $ | 20,513 |   | 7.29 | % | $ | 1,006,309 |   | $ | 16,505 |   | 6.51 | % |
| Taxable  investment securities                                               |       | 78,405                                                   |       | 832 |   | 4.21 |   | 67,565 |   | 495 |   | 2.91 |   |
| Investment  securities exempt from federal income taxes(3)                   |       | 16,335                                                   |       | 298 |   | 7.24 |   | 20,482 |   | 320 |   | 6.20 |   |
| Federal funds  sold                                                          |       | 271                                                      |       | 6 |   | 8.78 |   | 1,132 |   | 1 |   | 0.35 |   |
| Other interest  bearing deposits                                             |       | 12,000                                                   |       | 155 |   | 5.12 |   | 36,946 |   | 332 |   | 3.57 |   |
| Investment in  unconsolidated trust subsidiaries                             |       | 1,093                                                    |       | 22 |   | 7.99 |   | 992 |   | 22 |   | 8.80 |   |
| Total interest-earning assets                                                |       | 1,223,785                                                |       | 21,826 |   | 7.08 |   | 1,133,426 |   | 17,675 |   | 6.19 |   |
| Non-interest-earning assets                                                  |       | 61,820                                                   |       |   |   |   |   | 60,897 |   |   |   |   |   |
| Total assets                                                                 |       | $                                                        | 1,285,605  |   |   |   |   |   | $ | 1,194,323 |   |   |   |   |   |
| **Interest-Bearing  Liabilities:**                                           |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                                    |       |                                                     |       |   |   |   |   |   |   |   |   |   |   |
| NOW and money market deposits                                                |       | $                                                        | 100,396    |   | $ | 622 |   | 2.46 | % | $ | 81,140 |   | $ | 307 |   | 1.50 | % |
| Savings deposits                                                             |       | 405,609                                                  |       | 2,237 |   | 2.19 |   | 366,670 |   | 1,540 |   | 1.67 |   |
| Time deposits                                                                |       | 494,910                                                  |       | 5,897 |   | 4.73 |   | 432,890 |   | 3,786 |   | 3.47 |   |
| Short-term  borrowings                                                       |       | 20,509                                                   |       | 247 |   | 4.78 |   | — |   | — |   | — |   |
| Long-term  borrowings, including ESOP borrowings                             |       | 64,357                                                   |       | 623 |   | 3.84 |   | 86,164 |   | 846 |   | 3.90 |   |
| Junior  subordinated debt owed to unconsolidated trusts                      |       | 36,354                                                   |       | 760 |   | 8.29 |   | 32,992 |   | 714 |   | 8.59 |   |
| Total interest-bearing liabilities                                           |       | 1,122,135                                                |       | 10,386 |   | 3.67 |   | 999,856 |   | 7,193 |   | 2.85 |   |
| Demand  deposits—non-interest-bearing                                   |       | 38,265                                                   |       |   |   |   |   | 32,390 |   |   |   |   |   |
| Other  non-interest-bearing liabilities                                      |       | 43,701                                                   |       |   |   |   |   | 87,044 |   |   |   |   |   |
| Stockholders’  equity, including stock owned by ESOP                    |       | 81,504                                                   |       |   |   |   |   | 75,033 |   |   |   |   |   |
| Total liabilities and stockholders equity                                    |       | $                                                        | 1,285,605  |   |   |   |   |   | $ | 1,194,323 |   |   |   |   |   |
| Net interest income on a fully tax equivalent  basis/interest rate spread(4) |       |                                                     |       | $ | 11,440 |   | 3.41 | % |   |   | $ | 10,482 |   | 3.34 | % |
| Net interest margin on a fully tax equivalent  basis(5)                      |       |                                                     |       |   |   | 3.71 | % |   |   |   |   | 3.67 | % |
| Net interest  margin(5)                                                      |       |                                                     |       |   |   | 3.67 | % |   |   |   |   | 3.63 | % |

 

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(1)                                  Includes non-accrual loans of $8.0 million and$10.9 million for September 30, 2006 and 2005 respectively.

(2)                                  Interest income includes loan origination fees of$665 thousand and $888 thousand for the three months ended September 30, 2006and 2005, respectively.

(3)                                  Non-taxable investment income is presented on afully tax equivalent basis, adjusting for federal and state exemption ofinterest income and certain other permanent tax differences.

(4)                                  Interest rate spread represents the differencebetween the average yield on interest-earning assets and the average cost ofinterest-bearing liabilities and is presented on a fully tax equivalent basis.

(5)                                  Net interest margin represents net interest incomeas a percentage of average interest-earning assets.

14

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For the third quarter of 2006, net interest income ona fully tax equivalent basis increased $958 thousand (9.1%) to $11.4 millionfrom $10.5 million for the third quarter of 2005.  The increase in net interestincome resulted from an increase in interest income on a fully tax equivalentbasis of $4.2 million (23.5%), which was partially offset by an increase ininterest expense of $3.2 million (44.4%).  Interest income increasedmainly due to an increase in rate on earning assets of 89 basis points, whichaccounted for an increase of $2.5 million in interest income on a fully taxequivalent basis.  There was also an increase in average interest-earningassets of $90.4 million (8.0%), which accounted for an increase in interestincome on a fully tax equivalent basis of $1.6 million.  Interest expenseincreased mainly due to an increase in the cost of interest-bearing liabilitiesof 82 basis points, which accounted for $2.2 million of the increase.  Inaddition, average total interest-bearing liabilities increased $122.3 million(12.2%), accounting for $966 thousand of the increase in interestexpense.  The net interest margin expressed on a fully tax equivalentbasis increased 4 basis points to 3.71% for the quarter ended September 30,2006 from 3.67% for the quarter ended September 30, 2005.
| ** **                                                                   | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                   | ** ** | **2006**                                                | ** ** | **2005** | ** ** |
| ** **                                                                   | ** ** | **Average**                                             | ** ** | **Average** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                                   | ** ** | **Balance**                                             | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Yield/Rate** | ** ** |
| ** **                                                                   | ** ** | **(Dollars in thousands)**                    | ** ** |
| **Interest-Earning  Assets:**                                                |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Loans(1)(2)                                                                  |       | $                                                       | 1,078,343  |   | $ | 58,128 |   | 7.21 | % | $ | 966,584 |   | $ | 46,202 |   | 6.39 | % |
| Taxable  investment securities                                               |       | 89,240                                                  |       | 2,732 |   | 4.09 |   | 78,375 |   | 1,725 |   | 2.94 |   |
| Investment  securities exempt from federal income taxes(3)                   |       | 18,005                                                  |       | 940 |   | 6.98 |   | 18,342 |   | 866 |   | 6.31 |   |
| Federal funds  sold                                                          |       | 262                                                     |       | 11 |   | 5.61 |   | 998 |   | 9 |   | 1.21 |   |
| Other interest  bearing deposits                                             |       | 8,725                                                   |       | 308 |   | 4.72 |   | 17,236 |   | 431 |   | 3.34 |   |
| Investment in  unconsolidated trust subsidiaries                             |       | 1,026                                                   |       | 66 |   | 8.60 |   | 789 |   | 53 |   | 8.98 |   |
| Total interest-earning assets                                                |       | 1,195,601                                               |       | 62,185 |   | 6.95 |   | 1,082,324 |   | 49,286 |   | 6.09 |   |
| Non-interest-earning assets                                                  |       | 60,412                                                  |       |   |   |   |   | 64,775 |   |   |   |   |   |
| Total assets                                                                 |       | $                                                       | 1,256,013  |   |   |   |   |   | $ | 1,147,099 |   |   |   |   |   |
| **Interest-Bearing  Liabilities:**                                           |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| Deposits:                                                                    |       |                                                    |       |   |   |   |   |   |   |   |   |   |   |
| NOW and money market deposits                                                |       | $                                                       | 92,686     |   | $ | 1,465 |   | 2.11 | % | $ | 95,860 |   | $ | 829 |   | 1.16 | % |
| Savings deposits                                                             |       | 408,455                                                 |       | 6,121 |   | 2.00 |   | 377,491 |   | 4,030 |   | 1.43 |   |
| Time deposits                                                                |       | 467,613                                                 |       | 15,160 |   | 4.33 |   | 405,366 |   | 9,516 |   | 3.14 |   |
| Short-term  borrowings                                                       |       | 20,523                                                  |       | 666 |   | 4.34 |   | 6,133 |   | 123 |   | 2.68 |   |
| Long-term borrowings,  including ESOP borrowings                             |       | 65,707                                                  |       | 1,931 |   | 3.93 |   | 77,934 |   | 2,249 |   | 3.86 |   |
| Junior  subordinated debt owed to unconsolidated trusts                      |       | 34,125                                                  |       | 2,224 |   | 8.71 |   | 26,232 |   | 1,769 |   | 9.02 |   |
| Total interest-bearing liabilities                                           |       | 1,089,109                                               |       | 27,567 |   | 3.38 |   | 989,016 |   | 18,516 |   | 2.50 |   |
| Demand  deposits—non-interest-bearing                                   |       | 39,598                                                  |       |   |   |   |   | 35,434 |   |   |   |   |   |
| Other  non-interest-bearing liabilities                                      |       | 47,686                                                  |       |   |   |   |   | 49,089 |   |   |   |   |   |
| Stockholders’  equity, including stock owned by ESOP                    |       | 79,620                                                  |       |   |   |   |   | 73,560 |   |   |   |   |   |
| Total liabilities and stockholders equity                                    |       | $                                                       | 1,256,013  |   |   |   |   |   | $ | 1,147,099 |   |   |   |   |   |
| Net interest income on a fully tax equivalent  basis/interest rate spread(4) |       |                                                    |       | $ | 34,618 |   | 3.57 | % |   |   | $ | 30,770 |   | 3.59 | % |
| Net interest margin on a fully tax equivalent  basis(5)                      |       |                                                    |       |   |   | 3.87 | % |   |   |   |   | 3.80 | % |
| Net interest  margin(5)                                                      |       |                                                    |       |   |   | 3.83 | % |   |   |   |   | 3.76 | % |

 

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(1)                                  Includes non-accrual loans of $8.0 million and$7.3 million for September 30, 2006 and 2005 respectively.

(2)                                  Interest income includes loan origination fees of$2.5 million and $2.4 million for the nine months ended September 30, 2006 and2005, respectively.

(3)                                  Non-taxable investment income is presented on afully tax equivalent basis, adjusting for federal and state exemption ofinterest income and certain other permanent tax differences.

15

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(4)                                  Interest rate spread represents the differencebetween the average yield on interest-earning assets and the average cost ofinterest-bearing liabilities and is presented on a fully tax equivalent basis.

(5)                                  Net interest margin represents net interest incomeas a percentage of average interest-earning assets.

For the nine months ended September 30, 2006, netinterest income on a fully tax equivalent basis increased $3.8 million (12.5%)to $34.6 million from $30.8 million for the nine months endedSeptember 30, 2005.  The increase in net interest income resultedfrom an increase in interest income on a fully tax equivalent basis of $12.9million (26.2%), which was partially offset by an increase in interest expenseof $9.1 million (48.9%).  The increase in interest income on a fully tax equivalentbasis was mainly due to an increase on the yield of interest earning assets of86 basis points, which increased interest income on a fully tax equivalentbasis by $7.2 million.  There was also an increase in average interestearning assets of $113.3 million (10.5%), which accounted for $5.7 million ofthe increase.  The increase in interestexpense was due to an increase in the yield on interest bearing liabilities of88 basis points, which accounted for an increase in interest expense of $6.5million.  In addition, the averageinterest-bearing liabilities increased a total of $100.1 million (10.1%), whichincreased interest expense by $2.5 million, The net interest margin expressedon a fully tax equivalent basis increased 7 basis points to 3.87% for the ninemonth period ended September 30, 2006 from 3.80% for the same period in 2005.

***Volume, Mix and Rate Analysis of Net Interest Income.*** The following tables present the extent to which changes in volume, changes ininterest rates, and changes in the interest rates times the changes in volumeof interest earning assets and interest bearing liabilities have affected ourinterest income and interest expense during the periods indicated. Informationis provided on changes in each category due to (i) changes attributable tochanges in volume (change in volume times the prior period interest rate),(ii) changes attributable to changes in interest rate (changes in ratetimes the prior period volume) and (iii) changes attributable to changesin rate/volume (changes in interest rate times changes in volume). Changes attributable to the combined impact of volume and rate have beenallocated proportionally to the changes due to volume and the changes due torate.
|                                                            | ** ** | **Three Months Ended September 30,** | ** ** | **Nine Months Ended September 30,** | ** ** |
|------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                 | ** ** | **2006 Compared to 2005**                 | ** ** | **2006 Compared to 2005**                | ** ** |
| ** **                                                 | ** ** | **Change Due  to Volume**                      | ** ** | **Change Due  to Rate**                       | ** ** | **Total  Change** | ** ** | **Change Due  to Volume** | ** ** | **Change Due  to Rate** | ** ** | **Total  Change** | ** ** |
| ** **                                                 | ** ** | **(In thousands)**                                  | ** ** |
| **Interest  Earning Assets:**                              |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| Loans                                                      |       | $                                                        | 1,897      |                                                    | $          | 2,111 |   | $ | 4,008 |   | $ | 5,666 |   | $ | 6,260 |   | $ | 11,926 |   |
| Taxable  investment securities                             |       | 88                                                       |       | 249                                                     |       | 337 |   | 263 |   | 744 |   | 1,007 |   |
| Investment  securities exempt from federal income taxes(1) |       | (71                                                      | )          | 49                                                      |       | (22 | ) | (16 | ) | 90 |   | 74 |   |
| Federal funds  sold                                        |       | (2                                                       | )          | 7                                                       |       | 5 |   | (11 | ) | 13 |   | 2 |   |
| Other interest  bearing deposits                           |       | (283                                                     | )          | 106                                                     |       | (177 | ) | (260 | ) | 137 |   | (123 | ) |
| Investment in  unconsolidated trust subsidiaries           |       | 2                                                        |       | (2                                                      | )          | — |   | 15 |   | (2 | ) | 13 |   |
| Total increase (decrease) in interest income               |       | 1,631                                                    |       | 2,520                                                   |       | 4,151 |   | 5,657 |   | 7,242 |   | 12,899 |   |
| **Interest  Bearing Liabilities:**                         |       |                                                     |       |                                                    |       |   |   |   |   |   |   |   |   |
| NOW and money  market deposit accounts                     |       | $                                                        | 85         |                                                    | $          | 230 |   | $ | 315 |   | $ | (28 | ) | $ | 664 |   | $ | 636 |   |
| Savings deposits                                           |       | 177                                                      |       | 520                                                     |       | 697 |   | 353 |   | 1,738 |   | 2,091 |   |
| Time deposits                                              |       | 598                                                      |       | 1,513                                                   |       | 2,111 |   | 1,621 |   | 4,023 |   | 5,644 |   |
| Short-term  borrowings                                     |       | 247                                                      |       | —                                                  |       | 247 |   | 430 |   | 113 |   | 543 |   |
| Long-term  borrowings                                      |       | (211                                                     | )          | (12                                                     | )          | (223 | ) | (358 | ) | 40 |   | (318 | ) |
| Junior  subordinated debt owed to unconsolidated trusts    |       | 70                                                       |       | (24                                                     | )          | 46 |   | 516 |   | (61 | ) | 455 |   |
| Total increase (decrease) in interest expense              |       | 966                                                      |       | 2,227                                                   |       | 3,193 |   | 2,534 |   | 6,517 |   | 9,051 |   |
| Increase  (decrease) in net interest income                |       | $                                                        | 665        |                                                    | $          | 293 |   | $ | 958 |   | $ | 3,123 |   | $ | 725 |   | $ | 3,848 |   |

 

16

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(1)                                  Non-taxableinvestment income is presented on a fully tax equivalent basis, adjusting forfederal and state exemption of interest income and certain other permanentincome tax differences.

***Other Income.***  Changes in otherincome between the three months ended September 30, 2006 and 2005, andbetween the nine months ended September 30, 2006 and 2005, were asfollows:
|                              | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** |
|------------------------------|------------|----------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|
| ** **                   | ** ** | **September 30,**           | ** ** | **Net**    | ** ** | **September 30,**          | ** ** | **Net**    | ** ** |
| ** **                   | ** ** | **2006**                         | ** ** | **2005**   | ** ** | **difference**                  | ** ** | **2006**   | ** ** | **2005** | ** ** | **difference** | ** ** |
| ** **                   | ** ** | **(In thousands)**          | ** ** |
| Other income:                |       |                             |       |       |       |                            |       |       |       |   |   |   |   |
| Mortgage loan servicing fees |       | $                                | 662        |       | $          | 681                             |       | $          | (19        | ) | $ | 1,969 |   | $ | 1,942 |   | $ | 27 |   |
| Loan and other fees          |       | 732                              |       | 712        |       | 20                              |       | 2,253      |       | 2,009 |   | 244 |   |
| Service charges on deposits  |       | 386                              |       | 401        |       | (15                             | )          | 1,164      |       | 1,100 |   | 64 |   |
| Gain on sale of loans        |       | 538                              |       | 665        |       | (127                            | )          | 1,429      |       | 1,766 |   | (337 | ) |
| Other operating income       |       | 458                              |       | 414        |       | 44                              |       | 1,260      |       | 809 |   | 451 |   |
|                         |       | $                                | 2,776      |       | $          | 2,873                           |       | $          | (97        | ) | $ | 8,075 |   | $ | 7,626 |   | $ | 449 |   |

 

In the third quarter of 2006, other income decreasedby $97 thousand (3.4%) to $2.8 million from $2.9 million in the third quarterof 2005.  The gain on sale of loansdecreased $127 thousand (19.1%) due to lower volume of loans sold in 2006.  This lower volume is due to a general slowingof the real estate market experienced by all lenders in our market areas.  Partially offsetting this decrease, income generatedfrom TCC Appraisal (included in “Other operating income” above) was $78thousand.  As TCC Appraisal was notestablished until 2006, there was no income in this category in 2005.

In the first nine months of 2006, other incomeincreased by $449 thousand (5.9%) to $8.1 million from $7.6 million in thefirst nine months of 2005.  Income generated from TCC Appraisal in thefirst nine months of 2006 was $226 thousand and, as it had not yet beenestablished, TCC Appraisal did not generate any income in the first nine monthsof 2005.  Income from title insurancepremiums increased $96 thousand (11.6%) from the first nine months of 2005 tothe first nine months of 2006.  Net(loss) on sale of premises and equipment (included in “Other operating income”above) decreased $129 thousand (90.9%) due to a lower amount of equipmentdisposals in 2006 compared to 2005.  Loanand other fees increased $244 thousand (12.1%) in 2006, mainly due to anincrease in bankcard fees of $93 thousand (15.7%) and an increase in ATM switchfees of $114 thousand (19.3%).  The gainon sale of loans decreased $337 thousand (19.1%) due to a lower volume of loanssold and a lower premium made on the sale of each loan.

***Other Expenses.***  Changes in otherexpenses between the three months ended September 30, 2006 and 2005 andthe nine months ended September 30, 2006 and 2005 were as follows:
|                                                          | ** ** | **Three Months Ended** | ** ** | ** ** | ** ** | **Nine Months Ended** | ** ** | ** ** | ** ** |
|----------------------------------------------------------|------------|----------------------------------|------------|------------|------------|---------------------------------|------------|------------|------------|
| ** **                                               | ** ** | **September 30,**           | ** ** | **Net**    | ** ** | **September 30,**          | ** ** | **Net**    | ** ** |
| ** **                                               | ** ** | **2006**                         | ** ** | **2005**   | ** ** | **difference**                  | ** ** | **2006**   | ** ** | **2005** | ** ** | **difference** | ** ** |
| ** **                                               | ** ** | **(In thousands)**          | ** ** |
| Other expenses:                                          |       |                             |       |       |       |                            |       |       |       |   |   |   |   |
| Salaries and employee benefits                           |       | $                                | 4,065      |       | $          | 4,038                           |       | $          | 27         |   | $ | 12,913 |   | $ | 12,059 |   | $ | 854 |   |
| Occupancy                                                |       | 836                              |       | 785        |       | 51                              |       | 2,521      |       | 2,378 |   | 143 |   |
| Data processing                                          |       | 448                              |       | 486        |       | (38                             | )          | 1,343      |       | 1,391 |   | (48 | ) |
| Marketing                                                |       | 441                              |       | 403        |       | 38                              |       | 1,382      |       | 1,133 |   | 249 |   |
| Amortization and valuation of mortgage servicing  rights |       | 636                              |       | (162       | )          | 798                             |       | 1,658      |       | 902 |   | 756 |   |
| Supplies                                                 |       | 140                              |       | 159        |       | (19                             | )          | 490        |       | 559 |   | (69 | ) |
| Loss (gain) on sale of other real estate owned           |       | 8                                |       | 123        |       | (115                            | )          | 240        |       | 950 |   | (710 | ) |
| Postage                                                  |       | 142                              |       | 142        |       | —                          |       | 445        |       | 452 |   | (7 | ) |
| Other                                                    |       | 1,139                            |       | 931        |       | 208                             |       | 3,589      |       | 3,032 |   | 557 |   |
|                                                     |       | $                                | 7,855      |       | $          | 6,905                           |       | $          | 950        |   | $ | 24,581 |   | $ | 22,856 |   | $ | 1,725 |   |

 

17

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For the third quarter of 2006, other expensesincreased $950 thousand (13.8%) from the third quarter of 2005.  Amortization and valuation of mortgageservicing rights increased $798 thousand (492.6%), mainly due to a decrease inthe recovery of the valuation allowance in the third quarter of 2006 comparedto the third quarter of 2005.  This wasmainly due to relatively minor changes in long-term interest rates during 2006compared to 2005.  Items included in the “Other”category in the table above also increased: fees associated with derivativetransactions increased $144 thousand (144.0%) and collection and credit feespaid increased $73 thousand (83.0%).

For the nine months ended September 30, 2006, otherexpenses increased $1.7 million (7.5%) to $24.6 million from $22.9 million inthe first nine months of 2005.  This increase was largely due to anincrease in salaries and employee benefits of $854 thousand (7.1%), mainly dueto an increase in the number of employees and an increase in compensation peremployee.  The effect of adopting SFAS123(R) increased salary expense by $196 thousand.  Amortization and valuation of mortgageservicing rights increased $756 thousand (83.8%), mainly due to a decrease inthe recovery of the valuation allowance in the third quarter of 2006 comparedto the third quarter of 2005.  This wasmainly due to relatively minor changes in long-term interest rates during 2006compared to 2005.  Loss on sale of otherreal estate owned decreased $710 thousand (74.7%) due to large write-downs ofother real estate owned in 2005 that were not repeated in 2006.  Items included in the “Other” category in thetable above also increased: debit and credit card fees paid increased $145thousand (26.2%); collection and credit fees paid increased $115 thousand(153.3%); professional fees increased $103 thousand (29.7%); and feesassociated with derivative transactions increased $93 thousand (92.1%).

***Income Taxes.***  In the thirdquarter of 2006, income tax expense decreased $345 thousand (15.6%) over thethird quarter of 2005 to a total of $1.9 million compared to $2.2million.  The effective tax rate decreased to 37.7% in the third quarterof 2006 compared to 39.5% in the third quarter of 2005.  The decrease was mainly attributable to thetax benefit from the exercise of stock options in the third quarter of 2006 (asno options were exercised in the third quarter of 2005).

In the nine months ended September 30, 2006,income tax expense increased $179 thousand (3.6%), to a total of $5.1 millioncompared to $4.9 million.  The effective tax rate decreased to 37.6% inthe first nine months of 2006, compared to 37.7% in the first nine months of2005.

***Balance Sheet—General.***  Totalassets at September 30, 2006 were at $1.3 billion, an increase of $92.7million (7.4%) from December 31, 2005.  Net loans increased $102.6million (10.2%) during the first nine months of 2006.  There was also an increase in cash and cashequivalents of $22.2 million (40.6%). This was partially offset by a decline in investments of $29.7 million(23.6%).  During the same period, total liabilities increased by $85.8million (7.3%) to $1.3 billion on September 30, 2006 from $1.2 billion onDecember 31, 2005.  The increase in total liabilities was primarily due toan increase in deposits of $84.4 million (8.1%).  Stockholders’ equity(including stock owned by the Employee Stock Ownership Plan) increased $6.9million (9.1%) to $82.5 million on September 30, 2006 compared to $75.6 millionon December 31, 2005.

***Investment Securities.***  Theprimary purposes of the investment portfolio are to provide a source ofearnings for the purpose of managing liquidity, to provide collateral to pledgeagainst public deposits and to control interest rate risk. In managing theportfolio, we seek to obtain the objectives of safety of principal, liquidity,diversification and maximized return on funds. For an additional discussionwith respect to these matters, see “Liquidity and Sources of Capital” underItem 2 and “Asset Liability Management” under Item 3 below.

18

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The following tables set forth the amortized cost andfair value of our securities by accounting classification category and by typeof security as indicated:
| ** **                                                       | ** ** | **At September 30, 2006** | ** ** | **At December 31, 2005** | ** ** | **At September 30, 2005** | ** ** |
|------------------------------------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| ** **                                                       | ** ** | **Amortized Cost**                  | ** ** | **Fair Value**                     | ** ** | **Amortized Cost**                  | ** ** | **Fair Value** | ** ** | **Amortized Cost** | ** ** | **Fair Value** | ** ** |
| ** **                                                       | ** ** | **(In thousands)**                  | ** ** |
| Securities  Available for Sale:                                  |       |                                     |       |                                    |       |                                     |       |   |   |   |   |   |   |
| U.S. Government agencies                                         |       | $                                        | 66,494     |                                    | $          | 66,106                                   |       | $ | 85,687 |   | $ | 85,289 |   | $ | 35,146 |   | $ | 34,789 |   |
| States and political subdivisions                                |       | 9,532                                    |       | 9,553                                   |       | 5,984                                    |       | 5,937 |   | 5,995 |   | 5,967 |   |
| Equity securities                                                |       | 1                                        |       | 5                                       |       | 1                                        |       | 5 |   | 1 |   | 4 |   |
| Total securities available for sale                              |       | $                                        | 76,027     |                                    | $          | 75,664                                   |       | $ | 91,672 |   | $ | 91,231 |   | $ | 41,142 |   | $ | 40,760 |   |
|                                                             |       |                                     |       |                                    |       |                                     |       |   |   |   |   |   |   |
| Securities Held  to Maturity:                                    |       |                                     |       |                                    |       |                                     |       |   |   |   |   |   |   |
| U.S. Government agencies                                         |       | —                                   |       | —                                  |       | $                                        | 13,687     |   | $ | 13,647 |   | $ | 19,760 |   | $ | 19,719 |   |
| States and political subdivisions                                |       | $                                        | 11,179     |                                    | $          | 11,171                                   |       | 12,925 |   | 12,918 |   | 13,120 |   | 13,127 |   |
| Total securities held to maturity                                |       | $                                        | 11,179     |                                    | $          | 11,171                                   |       | $ | 26,612 |   | $ | 26,565 |   | $ | 32,880 |   | $ | 32,846 |   |
|                                                             |       |                                     |       |                                    |       |                                     |       |   |   |   |   |   |   |
| Other  securities:                                               |       |                                     |       |                                    |       |                                     |       |   |   |   |   |   |   |
| Non-marketable equity securities (including FRB and  FHLB stock) |       | $                                        | 8,000      |                                    | $          | 8,000                                    |       | $ | 6,973 |   | $ | 6,973 |   | $ | 7,016 |   | $ | 7,016 |   |
| Investment in unconsolidated trusts                              |       | 1,302                                    |       | 1,302                                   |       | 992                                      |       | 992 |   | 992 |   | 992 |   |
| Total other  securities                                          |       | $                                        | 9,302      |                                    | $          | 9,302                                    |       | $ | 7,965 |   | $ | 7,965 |   | $ | 8,008 |   | $ | 8,008 |   |

 

***Loan Portfolio.***  The followingtables set forth the composition of the loan portfolio:
|                            | ** ** | **At September 30, 2006** | ** ** | **At December 31, 2005** | ** ** | **At September 30, 2005** | ** ** |
|----------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| ** **                 | ** ** | **Amount**                               | ** ** | **Percent**                             | ** ** | **Amount**                               | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                 | ** ** | **(Dollars in thousands)**     | ** ** |
| Commercial                 |       | $                                        | 114,997    |                                    | 10.20      | %                                        | $          | 93,579 |   | 9.16 | % | $ | 90,837 |   | 9.01 | % |
| Commercial real  estate    |       | 397,611                                  |       | 35.27                                   |       | 379,884                                  |       | 37.19 |   | 383,149 |   | 38.02 |   |
| Residential real  estate   |       | 329,736                                  |       | 29.26                                   |       | 313,693                                  |       | 30.71 |   | 314,061 |   | 31.17 |   |
| Construction  real estate  |       | 227,393                                  |       | 20.18                                   |       | 178,068                                  |       | 17.43 |   | 165,195 |   | 16.39 |   |
| Installment and  other     |       | 57,356                                   |       | 5.09                                    |       | 56,309                                   |       | 5.51 |   | 54,471 |   | 5.41 |   |
| Total loans                |       | 1,127,093                                |       | 100.00                                  |       | 1,021,533                                |       | 100.00 |   | 1,007,713 |   | 100.00 |   |
| Unearned income            |       | (2,263                                   | )          |                                    |       | (2,153                                   | )          |   |   | (2,216 | ) |   |   |
| Gross loans                |       | 1,124,830                                |       |                                    |       | 1,019,380                                |       |   |   | 1,005,497 |   |   |   |
| Allowance for  loan losses |       | (11,657                                  | )          |                                    |       | (8,842                                   | )          |   |   | (9,850 | ) |   |   |
| Net loans                  |       | $                                        | 1,113,173  |                                    |       |                                     | $          | 1,010,538 |   |   |   | $ | 995,647 |   |   |   |

 

Total loans increased $105.6 million (10.3%) to $1.1billion at September 30, 2006 from $1.0 billion at December 31, 2005.  The increase was due primarily to growth inthe Company’s construction and commercial real estate and commercial loanportfolios.  There was a slight shiftfrom commercial real estate to construction real estate loans during thisperiod.

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***Asset Quality.***  The followingtable sets forth the amounts of non-performing loans and non-performing assetsat the dates indicated:
|                                                               | ** ** | **At September 30,  2006** | ** ** | **At December 31,  2005** | ** ** | **At September 30,  2005** | ** ** |
|---------------------------------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| ** **                                                    | ** ** | **(Dollars in Thousands)** | ** ** |
| Non-accruing  loans                                           |       | $                                    | 8,875      |                                | $          | 8,037                                |       | $ | 11,587 |   |
| Loans  90 days or more past due, still accruing interest |       | 34                                   |       | —                              |       | 69                                   |       |
| Total  non-performing loans                                   |       | 8,909                                |       | 8,037                               |       | 11,656                               |       |
| Other real  estate owned                                      |       | 25                                   |       | 375                                 |       | 330                                  |       |
| Other  repossessed assets                                     |       | 27                                   |       | 27                                  |       | 24                                   |       |
| Total  non-performing assets                                  |       | $                                    | 8,961      |                                | $          | 8,439                                |       | $ | 12,010 |   |
|                                                          |       |                                 |       |                                |       |                                 |       |
| Total  non-performing loans to total loans                    |       | 0.79                                 | %          | 0.79                                | %          | 1.16                                 | %          |
| Allowance for  loan losses to non-performing loans            |       | 130.85                               | %          | 110.02                              | %          | 84.5                                 | %          |
| Total non-performing  assets to total assets                  |       | 0.67                                 | %          | 0.68                                | %          | 0.98                                 | %          |

 

At September 30, 2006, total non-performing assetsincreased $522 thousand (6.2%) to $9.0 million from $8.4 million atDecember 31, 2005 primarily due to an increase in non-accruing loans of$838 thousand (10.4%).  This increase wasprimarily due to a commercial loan (with a balance of $799 thousand as ofSeptember 30, 2006) being put on non-accrual status during 2006.  This loan has been partially charged-off for$950 thousand, and the remainder is specifically identified as impaired.  The amount of $51 thousand in the allowancefor loan losses is allocated for this loan, the rest of the balance covered byadequate collateral in the form of commercial assets, inventory and accountsreceivable.

At September 30, 2006, total non-performing assetsdecreased $3.0 million (25.4%) to $9.0 million from $12.0 million at September30, 2005 primarily due to a decrease in non-accrual loans of $2.7 million(23.4%).  This decrease was primarily dueto the full repayment of all principal and interest of a commercial real estateloan of $2.4 million between the two periods.

***Allowance forLoan Losses.*** Management believes the allowance forloan losses accounting policy is critical to the portrayal and understanding ofthe Company’s financial condition and results of operations. As such, selectionand application of this “critical accounting policy” involves judgments,estimates, and uncertainties that are susceptible to change. In the event thatdifferent assumptions or conditions were to prevail, and depending upon theseverity of such changes, the possibility of materially different financialcondition or results of operations is a reasonable likelihood.

The allowance for loan losses is maintained at anamount that management believes will be appropriate to absorb probable losseson existing loans, based on an evaluation of the collectibility of loans andprior loss experience. This evaluation also takes into consideration such factorsas changes in the nature and volume of the loan portfolio, the value ofunderlying collateral, overall portfolio quality, review of specific problemloans and current economic conditions that may affect the borrower’s ability topay. While management uses the best information available to make itsevaluation, future adjustments to the allowance may be necessary if there aresignificant changes in economic conditions. In addition, as an integral part oftheir examination process regulatory agencies periodically review the Company’sallowance for loan losses and may require the Company to make additions to theallowance based on their evaluation of information available at the time oftheir examinations.

20

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The following table presents an analysis of the allowancefor loan losses for the periods presented:
|                                                | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                     | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                     | ** ** | **(Dollars in thousands)**                 | ** ** |
| Balance at  beginning of period                |       | $                                                    | 10,116     |                                                | $          | 9,364 |   | $ | 8,842 |   | $ | 8,367 |   |
| Provision for  loan losses                     |       | 1,322                                                |       | 750                                                 |       | 4,122 |   | 2,100 |   |
| Total  charge-offs                             |       | (89                                                  | )          | (311                                                | )          | (1,730 | ) | (740 | ) |
| Total recoveries                               |       | 308                                                  |       | 47                                                  |       | 423 |   | 123 |   |
| Net charge-offs                                |       | 219                                                  |       | (264                                                | )          | (1,307 | ) | (617 | ) |
| Balance at end  of period                      |       | $                                                    | 11,657     |                                                | $          | 9,850 |   | $ | 11,657 |   | $ | 9,850 |   |
|                                           |       |                                                 |       |                                                |       |   |   |   |   |
| Gross loans at  end of period                  |       | $                                                    | 1,124,830  |                                                | $          | 1,005,497 |   | $ | 1,124,830 |   | $ | 1,005,497 |   |
| Ratio of  allowance to total loans             |       | 1.04                                                 | %          | 0.98                                                | %          | 1.04 | % | 0.98 | % |
| Ratio of net  charge-offs to average loans (1) |       | (0.08                                                | )%         | 0.10                                                | %          | 0.16 | % | 0.09 | % |

 

----

(1)                                  Netcharge-offs are annualized for the purposes of this calculation.

Net charge-offs for the three months ended September30, 2006 totaled a $219 thousand recovery, a decrease of $483 thousand (183.0%)from a $264 thousand loss for the three months ended September 30, 2005. The majority of the recoveries were construction loans.  The provision forloan losses increased by $572 thousand (76.3%) for the three months endedSeptember 30, 2006, compared to the same period in 2005, due to management’sanalysis of current non-performing loans. See the discussion above on refinements made in the analysis for furtherdetails (see “Critical Accounting Policies—Allowance for Loan Losses”).

Net charge-offs for the nine months ended September30, 2006 totaled $1.3 million, an increase of $690 thousand (111.8%) from $617thousand for the nine months ended September 30, 2005.  The majority ofthe charge-offs were commercial loans.  The provision for loan lossesincreased by $2.0 million (96.3%) from the nine months ended September 30,2005.  Both the additional provision andthe additional charge-offs were primarily due to a single commercial loan of$950 thousand that was provided for and charged off during the first quarter of2006, as well as the increase in provision for loan losses per management’sanalysis of current non-performing loans. See the discussion above on refinements made in the analysis for furtherdetails (see “Critical Accounting Policies—Allowance for Loan Losses”).

The following table sets forth the allocation of theallowance for loan losses for the periods presented and the percentage of loansin each category to total loans. An allocation for a loan classification isonly for internal analysis of the adequacy of the allowance and is not anindication of expected or anticipated losses:
|                                         | ** ** | **At September 30, 2006** | ** ** | **At December 31, 2005** | ** ** | **At September 30, 2005** | ** ** |
|-----------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|------------------------------------------|------------|
| ** **                              | ** ** | **Amount**                               | ** ** | **Percent**                             | ** ** | **Amount**                               | ** ** | **Percent** | ** ** | **Amount** | ** ** | **Percent** | ** ** |
| ** **                              | ** ** | **(Dollars in thousands)**     | ** ** |
| Commercial                              |       | $                                        | 3,843      |                                    | 10.20      | %                                        | $          | 2,934 |   | 9.16 | % | $ | 3,681 |   | 9.01 | % |
| Commercial and  residential real estate |       | 4,261                                    |       | 64.53                                   |       | 3,086                                    |       | 67.90 |   | 3,513 |   | 69.19 |   |
| Construction  real estate               |       | 2,658                                    |       | 20.18                                   |       | 1,993                                    |       | 17.43 |   | 1,842 |   | 16.39 |   |
| Installment and  other                  |       | 883                                      |       | 5.09                                    |       | 813                                      |       | 5.51 |   | 802 |   | 5.41 |   |
| Unallocated                             |       | 12                                       |       | N/A                                     |       | 16                                       |       | N/A |   | 12 |   | N/A |   |
| Total                                   |       | $                                        | 11,657     |                                    | 100.00     | %                                        | $          | 8,842 |   | 100.00 | % | $ | 9,850 |   | 100.00 | % |

 

----

N/A—not applicable

21

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The portion of the allocationthat was based upon historical loss experience (based upon regression analysis)increased by $5.0 million (216.9%) in 2006, from $2.3 million on September 30,2005 to $7.3 million on September 30, 2006.  This was largely due toincreases in the allocation for commercial loans of $1.8 million, an increasein the allocation for commercial and residential real estate loans of $1.5million and an increase in the allocation for construction loans of $1.1million.  These adjustments werepartially due to moving from a pure historical loss analysis to a regressionanalysis as discussed above (see “Critical Accounting Policies—Allowancefor Loan Losses”).  The allocation based upon qualitativeadjustments decreased $2.5 million (48.7%), from $5.1 million on September 30,2005 to $2.6 million on September 30, 2006.  This was primarily due to adecrease in the allocation for commercial loans of $1.0 million and a decreasein the allocation for commercial and residential real estate loans of $722thousand.  These adjustments werepartially due to a quantification of these qualitative factors as discussedabove (see “Critical Accounting Policies—Allowance for Loan Losses”).  Theallocation for specifically identified loans decreased by $673 thousand(27.5%), from $2.4 million on September 30, 2005 to $1.8 million on September30, 2006.  This was primarily due to a decrease in specifically identifiedcommercial loans of $645 thousand.

We expect somewhat slower growth in our loan portfolioas the pace of economic expansion in the New Mexico economy has moderatedduring the past year along with continued increases in interest rates. Weanticipate the volume of commercial real estate and construction loans to slowas the construction industry’s home building boom appears to be ending andreturning to a more normal volume. Commercial real estate has strengthened over the past several years dueto vacancy rates returning to their historical averages and demand continuingto see new business looking to expand within the state. Although evidenceindicates that the construction boom is slowing, the sector for homes below$500 thousand remains strong with sales declining slightly but median pricesrising. We expect residential real estate for property worth greater than $1.5million to continue to be soft. Total net charge-offs were substantially morein the first three months of 2006 than in the same period in 2005 due to asingle large commercial loan, however charge offs returned to more historiclevels in the second and third quarters of 2006.

Additions to the allowance for loan losses, which arecharged to earnings through the provision for loan losses, are determined basedon a variety of factors, as indicated above. Although we believe the allowancefor loan losses is sufficient to cover probable losses inherent in the loanportfolio, there can be no assurance that the allowance will prove sufficientto cover actual loan losses.

***Potential Problem Loans.*****The Company utilizes an internal assetclassification system as a means of reporting problem and potential problemassets. At scheduled Board of Directors meetings every quarter, a list of totaladversely classified assets is presented, showing OREO, other repossessedassets, and all loans listed as “Substandard,” “Doubtful” and “Loss.”  Allnon-accrual loans are classed either as “Substandard” or “Doubtful” and arethus included in total adversely classified assets. A separate watch list ofloans classified as “Special Mention” is also presented. An asset is classifiedSubstandard if it is inadequately protected by the current net worth and payingcapacity of the obligor or of the collateral pledged, if any. Substandardassets include those characterized by the distinct possibility that the Companywill sustain some loss if the deficiencies are not corrected. Assets classifiedas Doubtful have all the weaknesses inherent in those classified Substandardwith the added characteristic that the weaknesses present make collection orliquidation in full, on the basis of currently existing facts, conditions andvalues, highly questionable and improbable. Assets classified as Loss are thoseconsidered uncollectible and viewed as non-bankable assets, worthy ofcharge-off. Assets that do not currently expose the Company to sufficient riskto warrant classification in one of the aforementioned categories, but possessweaknesses that may or may not be within the control of the customer are deemedto be Special Mention.

The Company’s determination as to the classificationof its assets and the amount of its valuation allowances is subject to reviewby the Bank’s primary regulators, which can order the establishment ofadditional general or specific loss allowances. The Comptroller of theCurrency, in conjunction with the other federal banking agencies, has adoptedan interagency policy statement on the allowance for loan losses. The policystatement provides guidance for financial institutions on both theresponsibilities of management for the assessment and establishment of adequateallowances and guidance for banking agency examiners to use in determining theadequacy of general valuation guidelines. Generally, the policy statementrecommends that (i) institutions have effective systems and controls toidentify, monitor and address asset quality problems; (ii) management hasanalyzed all significant factors that affect the collectibility of theportfolio in a reasonable manner; and (iii) management has establishedacceptable allowance evaluation processes that meet the objectives set forth inthe policy statement. Management believes it has established an adequateallowance for probable loan losses. The Company analyzes its process regularly,with modifications made, if needed, and reports those results quarterly atBoard of Directors meetings. However, there can be no assurance thatregulators, in reviewing the Company’s loan portfolio, will not request theCompany to materially increase its allowance for loan losses. Althoughmanagement believes that adequate specific and general loan loss allowanceshave been established, actual losses are dependent upon future events and, assuch, further additions to the level of specific and general loan lossallowances may become necessary.

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The following table shows theamounts of adversely classified assets and special mention loans as of theperiods indicated:
|                                    | ** ** | **At September 30,  2006** | ** ** | **At December 31,  2005** | ** ** | **At September 30,  2005** | ** ** |
|------------------------------------|------------|--------------------------------------|------------|-------------------------------------|------------|--------------------------------------|------------|
| ** **                         | ** ** | **(Dollars in thousands)** | ** ** |
| Loans classified  as:              |       |                                 |       |                                |       |                                 |       |
| Substandard                        |       | $                                    | 13,165     |                                | $          | 14,484                               |       | $ | 19,794 |   |
| Doubtful                           |       | 1,774                                |       | 1,414                               |       | 1,319                                |       |
| Total adversely  classified loans  |       | 14,939                               |       | 15,898                              |       | 21,113                               |       |
| Other real  estate owned           |       | 25                                   |       | 375                                 |       | 330                                  |       |
| Other  repossessed assets          |       | 27                                   |       | 27                                  |       | 24                                   |       |
| Total adversely  classified assets |       | $                                    | 14,991     |                                | $          | 16,300                               |       | $ | 21,467 |   |
|                               |       |                                 |       |                                |       |                                 |       |
| Special mention loans              |       | $                                    | 3,196      |                                | $          | 14,836                               |       | $ | 15,854 |   |

 

Total adversely classified assetsdecreased $6.5 million (30.2%) from September 30, 2005 to September 30,2006.  The main reason was a decrease of $6.6 million in substandardloans.  Substandard loans decreased because of  approximately $1.7 million in commercialloans and $2.4 million in commercial real estate loans that were paid-downand/or upgraded along with two commercial charge offs during the period whichapproximated $2.5 million.  Specialmention loans decreased $12.7 million (79.8%) between September 30, 2005 andSeptember 30, 2006, primarily due to commercial real estate loans upgraded fromthe risk category.

**Sources of Funds**

***Liquidityand Sources of Capital***

The Company’s cash flows arecomprised of three classifications: cash flows from operating activities, cashflows from investing activities and cash flows from financing activities. Netcash provided by operating activities was $16.0 million and $6.4 million forthe nine months ended September 30, 2006 and 2005 respectively.  Net cashprovided by operating activities increased $9.6 million in the first ninemonths of 2006 compared to the first nine months of 2005 largely due to a decreasein the origination of loans held for sale, net of sales, by $9.0 million overthe first nine months of 2005. Net cash used in investing activities was$(77.7) million and $(77.0) million for the nine months ended September 30,2006 and 2005, respectively.  Net cash provided by financing activitieswas $83.9 million and $133.4 million for the nine months ended September 30,2006 and 2005, respectively.  The $49.5 million decrease in cash providedby financing activities was mainly due to a decrease in new deposit growth of$56.6 million from the first nine months of 2006 compared to the first ninemonths of 2005.  This was partiallyoffset by a decrease in cash used by borrowings (net of repayments) of $4.2million and a decrease in the purchase of treasury stock of $3.0 million.

In the event that additional short-term liquidity isneeded, we have established relationships with several large regional banks toprovide short-term borrowings in the form of federal funds purchases. We haveborrowed, and management believes that we could again borrow up to$117.0 million for a short time from these banks on a collective basis.Additionally, we are a member of the FHLB and have the ability to borrow fromthe FHLB. As a contingency plan for significant funding needs, theAsset/Liability Management committee may also consider the sale of investmentsecurities, selling securities under agreement to repurchase, sale of certainloans and/or the temporary curtailment of lending activities.

At September 30, 2006, theCompany’s total risk-based capital ratio was 12.41%, the Tier 1 capital torisk-weighted assets ratio was 10.03%, and the Tier 1 capital to average assetsratio was 8.57%.  At December 31, 2005,the Company’s total risk-based capital ratio was 11.67%, the Tier 1 capital torisk-weighted assets ratio was 10.10%, and the Tier 1 capital to average assetsratio was 8.19%.

At September 30, 2006, the Bank’stotal risk-based capital ratio was 11.19%, the Tier 1 capital to risk-weightedassets ratio was 10.12%, and the Tier 1 capital to average assets ratio was8.65%.  At December 31, 2005, the Bank’stotal risk-based capital ratio was 11.30%, the Tier 1 capital to risk-weightedassets ratio was 10.41%, and the Tier 1 capital to average assets ratio was8.43%.  The Bank was categorized as “well-capitalized”under Federal Deposit Insurance Corporation regulations at September 30, 2006and December 31, 2005.

At September 30, 2006 andDecember 31, 2005, the Company’s book value per common share was $12.52 and $11.54,respectively.

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**Item 3. Quantitative and Qualitative Disclosures About Market Risk**

**Asset Liability Management**

The Company’s net interest incomeis subject to “interest rate risk” to the extent that it can vary based onchanges in the general level of interest rates. It is the Company’s policy tomaintain an acceptable level of interest rate risk over a range of possiblechanges in interest rates while remaining responsive to market demand for loanand deposit products.  The strategyemployed by the Company to manage its interest rate risk is to measure its riskusing an asset/liability simulation model and adjust the maturity of securitiesin its investment portfolio to manage that risk.

Interest rate risk can also bemeasured by analyzing the extent to which the repricing of assets andliabilities are mismatched to create an interest sensitivity “gap”.  An asset or liability is said to be interestrate sensitive within a specific time period if it will mature or repricewithin that time period.  The interestrate sensitivity gap is defined as the difference between the amount ofinterest earning assets maturing or repricing within a specific time period andthe amount of interest bearing liabilities maturing or repricing within thatsame time period.  A gap is consideredpositive when the amount of interest rate sensitive assets exceeds the amountof interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitiveliabilities exceeds the amount of interest rate sensitive assets.  During a period of rising interest rates,therefore, a negative gap would tend to adversely affect net interestincome.  Conversely, during a period offalling interest rates, a negative gap position would tend to result in anincrease in net interest income.

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The following table sets forththe amounts of interest earning assets and interest bearing liabilitiesoutstanding at September 30, 2006, which are anticipated by the Company, basedupon certain assumptions, to reprice or mature in each of the future timeperiods shown. Except as stated below, the amount of assets and liabilitiesshown which reprice or mature during a particular period were determined basedon the earlier of the term to repricing or the term to repayment of the assetor liability.  The table is intended toprovide an approximation of the projected repricing of assets and liabilitiesat September 30, 2006 on the basis of contractual maturities and scheduled rateadjustments within a three-month period and subsequent selected timeintervals.  The loan amounts in the tablereflect principal balances expected to be reinvested and/or repriced as aresult of contractual amortization and rate adjustments on adjustable-rateloans. Loan and investment securities contractual maturities and amortizationreflect modest prepayment assumptions. While NOW, money market and savings deposit accounts have adjustablerates, it is assumed that the interest rates on these accounts will not adjustimmediately to changes in other interest rates. Therefore, the table is calculated assuming that these accounts willreprice based upon an historical analysis of rate changes of these particularaccounts, with repricing assigned to these accounts from one to 11 months.
| ** **                                             | ** ** | **Time to Maturity or Repricing** | ** ** |
|--------------------------------------------------------|------------|-------------------------------------------------------|------------|
| **As of September 30, 2006:**      | ** ** | **0-90 Days**                                    | ** ** | **91-365 Days** | ** ** | **1-5 Years** | ** ** | **Over 5 Years** | ** ** | **Total** | ** ** |
| ** **                                             | ** ** | **(In thousands)**                               | ** ** |
| **Interest-Earning Assets:**                           |       |                                                  |       |   |   |   |   |   |   |   |   |
| Loans                                                  |       | $                                                     | 544,044    |   | $ | 453,848 |   | $ | 56,870 |   | $ | 70,068 |   | $ | 1,124,830 |   |
| Loans held for sale                                    |       | 5,479                                                 |       | — |   | — |   | — |   | 5,479 |   |
| Investment securities                                  |       | 19,089                                                |       | 38,335 |   | 29,681 |   | 7,738 |   | 94,843 |   |
| Securities purchased under agreements to resell        |       | 252                                                   |       | — |   | — |   | — |   | 252 |   |
| Interest bearing deposits with banks                   |       | 54,759                                                |       | — |   | — |   | — |   | 54,759 |   |
| Investment in unconsolidated trusts                    |       | 186                                                   |       | — |   | — |   | 1,116 |   | 1,302 |   |
| Total interest-earning  assets                         |       | $                                                     | 623,809    |   | $ | 492,183 |   | $ | 86,551 |   | $ | 78,922 |   | $ | 1,281,465 |   |
|                                                   |       |                                                  |       |   |   |   |   |   |   |   |   |
| **Interest-Bearing Liabilities:**                      |       |                                                  |       |   |   |   |   |   |   |   |   |
| NOW and money market deposit accounts                  |       | $                                                     | 98,023     |   | $ | 166,955 |   | — |   | — |   | $ | 264,978 |   |
| Savings deposits                                       |       | 159,497                                               |       | 79,070 |   | — |   | — |   | 238,567 |   |
| Time deposits                                          |       | 113,642                                               |       | 275,293 |   | $ | 132,361 |   | $ | 7,300 |   | 528,596 |   |
| Short- and long-term borrowings                        |       | 12,034                                                |       | 702 |   | 18,904 |   | 44,681 |   | 76,321 |   |
| Borrowings made by ESOP to outside parties             |       | 743                                                   |       | — |   | — |   | — |   | 743 |   |
| Junior subordinated debt owed to unconsolidated trusts |       | 6,186                                                 |       | — |   | — |   | 37,116 |   | 43,302 |   |
| Total interest-bearing  liabilities                    |       | $                                                     | 390,125    |   | $ | 522,020 |   | $ | 151,265 |   | $ | 89,097 |   | $ | 1,152,507 |   |
|                                                   |       |                                                  |       |   |   |   |   |   |   |   |   |
| Rate sensitive assets (RSA)                            |       | $                                                     | 623,809    |   | $ | 1,115,992 |   | $ | 1,202,543 |   | $ | 1,281,465 |   | $ | 1,281,465 |   |
| Rate sensitive liabilities (RSL)                       |       | 390,125                                               |       | 912,145 |   | 1,063,410 |   | 1,152,507 |   | 1,152,507 |   |
| Cumulative GAP (GAP=RSA-RSL)                           |       | 233,684                                               |       | 203,847 |   | 139,133 |   | 128,958 |   | 128,958 |   |
| RSA/Total assets                                       |       | 46.67                                                 | %          | 83.49 | % | 89.96 | % | 95.87 | % | 95.87 | % |
| RSL/Total assets                                       |       | 29.19                                                 | %          | 68.24 | % | 79.56 | % | 86.22 | % | 86.22 | % |
| GAP/Total assets                                       |       | 17.48                                                 | %          | 15.25 | % | 10.40 | % | 9.65 | % | 9.65 | % |
| GAP/RSA                                                |       | 37.46                                                 | %          | 18.27 | % | 11.57 | % | 10.06 | % | 10.06 | % |

 

Certain shortcomings are inherent in the method ofanalysis presented in the foregoing table. For example, although certain assetsand liabilities may have similar maturities or periods to repricing, they mayreact in different degrees to changes in market interest rates. Also, theinterest rates on certain types of assets and liabilities may fluctuate inadvance of changes in market interest rates, while interest rates on othertypes of assets may lag behind changes in market rates.  Additionally, inthe event of a change in interest rates, prepayment and early withdrawal levelswould likely deviate significantly from those assumed in calculating thetable.  Therefore, the Company does not rely solely on a gap analysis tomanage its interest rate risk, but rather it uses what it believes to be themore reliable simulation model relating to changes in net interest income asset forth below.

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Changes in net interest income between the periodsbelow reflect changes in the composition of interest-earning assets andinterest-bearing liabilities, related interest rates, repricing frequencies,and the fixed or variable characteristics of the interest-earning assets andinterest-bearing liabilities.  Projections of income given by the modelare not actual predictions, but rather show our relative interest raterisk.  Actual interest income may vary from model projections.  Basedon simulation modeling at September 30, 2006 and December 31, 2005, theCompany’s net interest income would change over a one-year time period due tochanges in interest rates as follows:

**Changein Net Interest Income Over One Year Horizon**
| Changes in Levels of | ** ** | **At September 30, 2006** | ** ** | **At December 31, 2005** | ** ** |
|-------------------------------------|------------|------------------------------------------|------------|-----------------------------------------|------------|
| **Interest Rates**             | ** ** | **Dollar Change**                   | ** ** | **Percentage Change**              | ** ** | **Dollar Change** | ** ** | **Percentage Change** | ** ** |
| ** **                          | ** ** | **(Dollars in thousands)**     | ** ** |
| + 2.00                              | %          | $                                        | (2,395     | )                                       | (4.99      | )% | $ | (3,093 | ) | (7.21 | )% |
| + 1.00                              |       | (475                                     | )          | (0.99                                   | )          | (948 | ) | (2.21 | ) |
| (1.00                               | )          | 269                                      |       | 0.56                                    |       | 1,047 |   | 2.44 |   |
| (2.00                               | )          | (1,521                                   | )          | (3.17                                   | )          | 721 |   | 1.68 |   |
|                                     |            |                                          |            |                                         |            |  |  |  |  |  |  |

 

Simulations used by the Company assume the following:

1.                                       Changesin interest rates are immediate.

2.                                       Itis the Company’s policy that interest rate exposure due to a 2.00% interestrate rise or fall be limited to 15.0% of the Company’s annual net interestincome, as forecasted by the simulation model. As demonstrated by the tableabove, the Company’s interest rate risk exposure was within this policy atSeptember 30, 2006.

**Item 4.  Controls and Procedures.**

**Evaluation of Disclosure Controls and Procedures**

As required byRules 13a-15(b) and 15d-15(b) under the Securities Exchange Act of 1934,management has evaluated, with the participation of our Chief Executive Officerand Chief Financial Officer, the effectiveness of our disclosure controls andprocedures as of the end of the period covered by this report. Based on theirevaluation, management concluded our disclosure controls and procedures (asdefined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) wereeffective as of September 30, 2006 to ensure that information required to bedisclosed by us in reports that we file or submit under the Securities ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in Securities and Exchange Commission rules and forms and wereeffective as of September 30, 2006.  These disclosure controls andprocedures include controls and procedures designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theSecurities Exchange Act is accumulated and communicated to management,including our Chief Executive Officer and Chief Financial Officer, or personsperforming similar functions, as appropriate to allow timely decisionsregarding required disclosure.

**Changes in Internal Control overFinancial Reporting.**

There have been no changes to our internal controlsover financial reporting during the last fiscal quarter that have affected, orare reasonably likely to affect, our internal controls over financialreporting.

**PART II — OTHER INFORMATION**

**Item 1.   Legal Proceedings**

Neither Trinity, the Bank, TitleGuaranty, TCC Appraisal Services, TCC Advisors or TCC Funds are involved in anypending legal proceedings other than routine legal proceedings occurring in thenormal course of business, which, in the opinion of management, in theaggregate, are material to our consolidated financial condition.

**Item 1A. Risk Factors**

In addition to the other information in this QuarterlyReport on Form 10-Q, shareholders or prospective investors should carefullyconsider the risk factors appearing in Trinity’s Form 10-K for the year-ending2005 filed with the Securities and Exchange Commission on March 16, 2006beginning on page 9. There have been no material changes to the risk factors aspreviously disclosed in Trinity’s Form 10-K.

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**Item 2. Unregistered Sales of Equity Securities and Use of Proceeds**

None

**Item 3.  Defaults Upon SeniorSecurities**

None

**Item 4.  Submission of Mattersto a Vote of Security Holders**

None

**Item 5.  Other Information**

None

**Item 6.  Exhibits**

4.5                                 Indenturefor Trinity Capital Corporation as issuer of Trust Preferred Securities, datedSeptember 21, 2006

31.1                           Certificationof Chief Executive Officer Pursuant to Rule 13a-14(a)/15d-14(a)

31.2                           Certificationof Chief Financial Officer Pursuant to Rule 13a-14(a)/15d-14(a)

32.1                           Certificationof Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2                           Certificationof Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as AdoptedPursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

**SIGNATURES**

Pursuant to the requirements of the SecuritiesExchange Act of 1934, the registrant has duly caused this registrationstatement to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|                        | **TRINITY CAPITAL CORPORATION** |
|------------------------|---------------------------------|
|                   |                            |   |
|                   |                            |   |
| Date: November 9, 2006 | By:                             | /s/  WILLIAM C. ENLOE |
|                   |                            | William C.  Enloe |
|                   |                            | President and Chief  Executive Officer |
|                   |                            |   |
|                   |                            |   |
| Date: November 9, 2006 | By:                             | /s/ DANIEL R.  BARTHOLOMEW |
|                   |                            | Daniel R.  Bartholomew |
|                   |                            | Chief Financial  Officer |

 

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